SECURITIES & EXCHANGE COMMISSION EDGAR FILING
Form: 10-K
Date Filed: 2011-03-31
Corporate Issuer CIK: 771999
© Copyright 2014, Issuer Direct Corporation. All Right Reserved. Distribution of this document is strictly prohibited, subject to the
terms of use.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
☑ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
or
❑ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number 1-32146
DOCUMENT SECURITY SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
New York
(State or other jurisdiction of incorporation or organization)
16-1229730
(I.R.S.Employer Identification Number)
First Federal Plaza
28 East Main Street, Suite 1525
Rochester, New York 14614
(Address of principal executive offices)
(585) 325-3610
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, par value $0.02 per share
Name of each exchange on which registered
NYSE Amex Equities
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.
YES ❑ NO ☑
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Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the
Act. YES ❑ NO ☑
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. YES ☑ NO ❑
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit and post such files).
YES ❑ NO ❑
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. ❑
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Large Accelerated Filer ❑ Accelerated Filer ❑ Non-Accelerated Filer (Do not check if a smaller reporting company) o Smaller
Reporting Company ☑
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act). Yes ❑ No ☑
The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant computed by reference to the closing
price of such common stock as reported on the NYSE Amex Equities exchange on June 30, 2010, was $40,543,056.
The number of shares of the registrant’s common stock outstanding as of March 25, 2011, was 19,498,884.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement relating to the registrant’s 2011 Annual Meeting of Stockholders, to be held on June 9, 2011
are incorporated by reference into Part III of this Annual Report on Form 10-K.
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DOCUMENT SECURITY SYSTEMS, INC. & SUBSIDIARIES
Table of Contents
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 3.
ITEM 5.
ITEM 7.
ITEM 8.
ITEM 9.
BUSINESS
RISK FACTORS
PROPERTIES
LEGAL PROCEEDINGS
PART I
PART II
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A.
CONTROLS AND PROCEDURES
PART III
ITEM 10.
ITEM 11.
ITEM 12.
ITEM 13.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
EXECUTIVE COMPENSATION
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
DIRECTOR INDEPENDENCE
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
SIGNATURES
PART IV
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14
14
16
17
28
29
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30
30
30
30
30
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ITEM 1 - BUSINESS
Overview
Document Security Systems, Inc. (referred to in this report as “Document Security Systems”, “Document Security,” “DSS,” “we,”
“us,” “our” or “Company”) develops, markets, manufactures and sells paper and plastic products designed to protect valuable information
from unauthorized scanning, copying, and digital imaging. We have developed security technologies that are applied during the normal
printing process and by all printing methods including traditional offset, gravure, flexo, digital or via the internet on paper, plastic, or
packaging. Our technologies and products are used by federal, state and local governments, law enforcement agencies and are also
applied to a broad variety of industries as well, including financial institutions, high technology and consumer goods, entertainment and
gaming, healthcare/pharmaceutical, defense and genuine parts industries. Our customers use our technologies where there is a need for
enhanced security for protection and verification of critical financial instruments and vital records, or where there are concerns of
counterfeiting, fraud, identity theft, brand protection and liability.
We were organized as a New York corporation in 1984, and in 2002, chose to strategically focus on becoming a developer and
marketer of secure technologies for all forms of print media. The basis of our document security business in our early stages was
several patents, research and development and knowledge we acquired from privately held document security technology businesses in
2002 and 2003. Our business model focused on developing anti-copying technologies for the printing industry. We now have numerous
patents, patent pendings, trademarks and trade secrets that form the basis of our security technology offerings. Our competitive position
in the security printing market is based on our attention to the research and development of technologies, ideas and know-how that
combat a widening range of copying, scanning and other duplication devices that exist in today’s market that can be used for
counterfeiting and unauthorized duplication of sensitive information and images. In 2006, we began to expand our strategic focus to
become a full service provider of documents securing products to the end-user customer.
Prior to 2006, the Company’s primary revenue source in its document security division was derived from the licensing of its
technology. The Company had limited production capabilities. In 2006, the Company began to expand its ability to be a provider of anti-
counterfeiting products that utilize the Company’s anti-counterfeiting technologies. In 2006, we acquired Plastic Printing Professionals,
Inc. (“P3”), a privately held plastic cards manufacturer located in the San Francisco, CA area. P3’s primary focus is manufacturing long-
life composite, laminated and surface printed cards which can include magnetic stripes, bar codes, holograms, signature panels, invisible
ink, micro fine printing, guilloche patterns, Biometric, RFID and a patent-pending watermark technology. P3’s products are marketed
through an extensive broker network that covers much of North America, Europe and South America and by manufacturing for various
industry integrators.
In December 2008, we acquired substantially all of the assets of DPI of Rochester, LLC, a privately held commercial printer
located in Rochester, NY. We formed DPI Secuprint (“DPI”) to incorporate this new company which significantly improved our ability to
produce our security paper products as well as improving our competitiveness in the market for custom security printing, especially in the
areas of vital records, secure coupons, transcripts, and prescription paper along with the ability to offer our customers a wider range of
commercial printing offerings.
In February 2010, the Company acquired Premier Packaging Corporation (“Premier Packaging”), a privately held packaging
company located in the Rochester NY area. Premier Packaging is an ISO 9001:2008 registered manufacturer of custom paperboard
packaging serving clients in the pharmaceutical, beverage, photo packaging, toy, specialty foods and direct marketing industries, among
others. The Company expects the acquisition will allow it to introduce anti-counterfeiting products to the packaging market that further
expands the usage of its technologies. The Company believes that the ability to deter and prevent counterfeiting of brand packaging will
provide major benefits to companies around the globe which are affected by product counterfeiting.
In 2010, we generated revenue of $13.4 million, a 35% increase compared to 2009. The increase was primarily due to the
acquisition of Premier Packaging in the early part of 2010. The increase in revenue caused by the acquisition of Premier Packaging
more than offset decreases in revenue experienced by the Company’s other divisions, Document Security Systems, DPI and P3, and the
loss of revenue as a result of the Company’s divestiture of its legal products division in October of 2009. In October 2010, we distributed
our shares of Internet Media Services in the form of a dividend to our shareholders.
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Our Core Products, Technology and Services
Our core business is counterfeit prevention, brand protection and validation of authentic print media, including government-issued
documents, aerospace industry spare parts documents, packaging, ID Cards, licenses and more. We believe we are a leader in the
research and development of optical deterrent technologies and have commercialized these technologies with a suite of products that
offer our customers an array of document security solutions. We provide document security technology to security printers,
corporations, consumer product companies and governments worldwide and for currency, identifications, certifications, travel documents,
prescription and medical forms, consumer product and pharmaceutical packaging, and school transcripts.
Our products can be delivered on paper, plastic, packaging, or digitally via our AuthentiGuard® DX™ product suite. We believe
that our continued efforts in the field of digital security and technology greatly expands the reach and potential market for our
AuthentiGuard® DX™ digital products and enterprise solutions. We believe that our AuthentiGuard® DX™ solution significantly changes
the economics of document security for many customers as it eliminates the requirement to utilize pre-printed forms while allowing
customers to leverage existing investments in their information technology infrastructure.
Technologies
We have developed or acquired over 30 technologies that provide to our customers a wide spectrum of solutions.
The Company’s primary anti-counterfeiting products and technologies are marketed under the following trade names:
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AuthentiGuard™ DX™
AuthentiGuard® Laser Moiré™
AuthentiGuard® Prism™
AuthentiGuard® Pantograph 4000™
AuthentiGuard® Phantom™
AuthentiGuard® VeriGlow™
AuthentiGuard® Survivor 21®
AuthentiGuard® Block-Out™
AuthentiGuard® MicroPerf™
Products and Services
Generic Security Paper: Our primary product for the retail end-user market is AuthentiGuard® Security Paper. AuthentiGuard®
Security Paper is blank paper that contains our Pantograph 4000TM technology. The paper reveals hidden warning words, logos or
images using The Authenticator- our proprietary viewing lens – when the paper is faxed, copied or scanned. The hidden words appear
on the duplicate or the computer digital file and essentially prevent documents, including forms, coupons and tickets, from being
counterfeited.
Security and non-security printing: We believe our technology portfolio allows us to create unique custom secure paper,
plastic, packaging and Internet-based and software enterprise solutions. We market and sell to end-users that require anti-counterfeiting
and authentication features in a wide range of printed materials such as documents, vital records, prescription paper, driver’s licenses,
birth certificates, receipts, manuals, identification materials, entertainment tickets, secure coupons, parts tracking forms, as well as
product packaging including pharmaceutical and a wide range of consumer goods. In addition, we provide a full range of digital and
large offset commercial printing capabilities to our customers.
In our early stages, we had primarily outsourced the production of our custom security print orders to strategic printing
vendors. In December 2008, we acquired a commercial printer with long run offset and short run digital printing capabilities that will
allow us to produce the majority of our security print orders in house. We produce our plastic printed documents such as ID cards,
event badges, and driver licenses at our manufacturing facility in Brisbane, California under the name P3. In late 2007, we moved our P3
manufacturing facility to a 25,000 square foot facility in order to increase our plastic manufacturing capacity, and during 2008, we
upgraded their production capabilities by adding equipment that will improve its productivity, along with equipment for high speed data
encoding and equipment for production of high-volume precision RFID cards.
Packaging: We produce our secure and non-secure packaging products such as boxes, mailers, and point of sale displays,
utilizing a CAD/CAM design system that allows for early stage prototyping at our manufacturing facility in Victor, New York. Our
packaging division offers automated die cutting, high speed folding, gluing, window and paper patching, automated in-line inserting, pick
and place and tip-on systems. We can incorporate our security technologies into printed packaging to help companies prevent or deter
brand and product counterfeiting. In addition, our technologies and services can be integrated into various supply chain anti-diversion
programs such as track and trace that deter product diversion throughout the supply chain.
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Digital Security Solutions: Using software that we have developed, we can electronically render several of our technologies
digitally to extend the use of optical security to the end-user of sensitive information. With our AuthentiGuard® DX™ we market a
networked appliance that allows the author of any Microsoft Office document (Outlook, Word, Excel, or PowerPoint) to secure nearly any
of its alphanumeric content when it is printed or digitally stored. AuthentiGuard® DX prints selected content using our patented
technology so that it cannot be read by the naked eye. Reading the hidden content, or authenticating the document is performed with a
proprietary viewing device or software.
The Company has developed an internet delivered technology called AuthentiGuard® – On Demand™ where information is
hidden and then verified utilizing an inexpensive viewing glass. This technology is currently being utilized by a Central American country
for travel visas.
The Company has also developed digital versions of its AuthentiGuard® – Prism™ and AuthentiGuard® – Pantograph
4000™ technologies which are produced on HP Indigo Presses, Canon Color Copiers, Ricoh Color Copiers and Konica Desktop
Printers. The Company sells the digital products directly through its internal sales force and it has also entered into a contract to sell its
digital solutions through a third party who specializes in hardware software engineering solutions.
Technology Licensing: We license our anti-counterfeiting technology and trade secrets to security printers through licensing
arrangements. We seek licensees that have a broad customer base that can benefit from our technologies or have unique and strategic
capabilities that expand the capabilities that we can offer our potential customers. Licenses can be for a single technology or for a
package of technologies. We offer licensees a variety of pricing models, including:
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Pay us one price per year;
Pay us a percentage of gross sales price of the product containing the technology during the term;
Joint venture or profit sharing arrangements; and
Pay Per Finished Piece.
Legal Products: We also owned and operated, through our wholly-owned subsidiary, Legalstore, an Internet company which
sold legal supplies and documents, including security paper and products for the users of legal documents and supplies in the legal,
medical and educational fields. On October 8, 2009 we sold the assets and liabilities associated with Legalstore to Internet Media
Services, Inc. (“Internet Media Services”) in exchange for 7,500,000 shares of its common stock representing approximately 37% of the
outstanding shares of Internet Media Services. In October 2010, we distributed our shares of Internet Media Services in the form of a
dividend to our shareholders.
Intellectual Property
Patents
Our ability to compete effectively depends in part on our ability to maintain the proprietary nature of our technology, products and
manufacturing processes. We principally rely upon patent, trademark, trade secrets and contract law to establish and protect our
proprietary rights. During our development, we have expended a significant percentage of our resources on research and development to
ensure that we are a market leader with the ability to provide our customers effective solutions against a never changing array of
counterfeit risks. Our position in the security print market is based on our technologies and products. We dedicate 2 staff members to
research and development of print technologies, digital graphic files, and printing techniques that allow us to expand our ability to combat
a wide variety of counterfeiting and brand protection issues. In 2010 and 2009, we spent approximately $265,000 and $291,000
respectively, on research and development which is comprised mainly of compensation costs, materials and third-party services.
Based largely on these efforts, we currently hold numerous patents and have numerous patent applications in process,
including provisional and PCT patent applications and applications that have entered the National Phase in various countries including
the United States, Canada, Europe, Japan, Brazil, Israel, Mexico, Indonesia and South Africa. These applications cover our
technologies, including our AuthentiGuard® On-Demand and ADX, AuthentiGuard® Prism™, AuthentiGuard® Phantom™,
AuthentiGuard® ObscuraScan™, AuthentiGuard® Survivor 21™, AuthentiGuard® VeriGlow™ products, and several other anti-
counterfeiting and authentication technologies in development.
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In addition to our current patent activities, we own several patents that we acquired in 2002 when we acquired companies owned by
various members of the Wicker Family and The Estate of Ralph Wicker, including US Patents 5,018,767, European Patent 0455750,
Canadian Patent 2,045,580, and a 50% ownership of US Patent No 5,735,547 (collectively, the “Wicker Patents”). However, due to
previous contractual agreements associated with the Wicker Patents, we did not obtain certain economic rights to these patents,
including certain economic rights to benefits derived from settlements, licenses or other subsequent business arrangements from any
person or entity that had been proven to infringe these patents. Therefore, to consolidate our ownership and economic rights to the
Wicker Patents, we entered into the following transactions.
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In 2004, we entered into an agreement with The Estate of Ralph Wicker and its assigns to purchase from them the right to 70%
of the future economic benefit derived from settlements, licenses or subsequent business arrangements from any infringer of the
Wicker Patents that we choose to pursue, with The Estate of Ralph Wicker receiving the remaining 30% of such economic
benefit.
In February 2005, we further consolidated our ownership of the Wicker Patents by purchasing the economic interests and
ownership from 45 persons and entities that had purchased various rights in Wicker Family technologies, including the Wicker
Patents. As a result of this transaction, we increased our ownership of US Patent 5,735,547 to 100%, and increased our right to
future economic benefits relating to the Wicker Patents to approximately 86% of all settlements or license royalties derived from,
among other things, infringement suits related to the foreign Wicker Patents, including European Patent 0455750. Pursuant to
these transactions, we issued an aggregate of 541,460 shares of our common stock, valued at approximately $3.9 million to
these 45 persons and entities.
In August 2005, the Company commenced a suit against the European Central Bank (“ECB”) alleging patent infringement by the
ECB and claimed unspecified damages. We brought the suit in the European Court of First Instance in Luxembourg. We alleged that all
Euro banknotes in circulation infringe the Company European Patent 0 455 750B1 (the “Patent”), which covers a method of incorporating
an anti-counterfeiting feature into banknotes or similar security documents to protect against forgeries by digital scanning and copying
devices. Commencing in March 2006, the ECB countersued in eight national courts alleging that the Patent was invalid. Through
August 2008, the Company spent approximately $4.2 million dollars on legal, expert and consulting fees for its case. In August 2008,
the Company decided to reduce its cost burden associated with the case and entered into an agreement with Trebuchet Capital
Partners, LLC (“Trebuchet”) under which Trebuchet agreed to pay substantially all of the litigation costs associated with pending validity
proceedings and future validity and future patent infringement suits filed against the ECB and certain other alleged infringers of the Patent
in exchange for 50% of any future proceeds or settlements associated with the litigation. The Patent has been confirmed to be valid and
enforceable in one jurisdiction (Spain) that used the Euro as its national currency allowing the Company or Trebuchet, on the Company’s
behalf, to proceed with infringement cases in Spain if we choose to do so.
By aggressively defending our intellectual property rights, we believe that we may be able to secure a potentially significant
amount of additional and ongoing revenue by securing proceeds from lawsuits, settlements, or licensing agreements with those persons,
companies or governments that we believe are infringing our patents. We intend to use the appropriate legal means that are
economically feasible to protect our ownership of these technologies. We cannot be assured, however, that our efforts to prevent the
misappropriation of the intellectual property used in our business will be successful, or that we will be successful in obtaining monetary
proceeds from entities that we believe are infringing our patents. Further, we cannot be assured that any patents will be issued for our
U.S. or foreign applications or that, if issued, they will provide protection against competitive technologies or will be held valid and
enforceable if challenged. We also cannot be assured that competitors would not be able to design around any such proprietary right or
obtain rights that we would need to license or design around in order to practice under these patents.
Trademarks
We have registered our “AuthentiGuard” mark, as well as our “Survivor 21” electronic check icon with the U.S. Patent and
Trademark Office. A trademark application is pending in Canada for “AuthentiGuard.” AuthentiGuard® is registered in several European
countries including the United Kingdom.
Major Customers
During 2010, two customers accounted for 25% and 10% of the Company’s total revenue from continuing operations. As of
December 31, 2010, these customers accounted for 37% and 7% of the Company’s trade accounts receivable balance,
respectively. During 2009, two customers accounted for 19% and 12% of the Company’s total revenue from continuing operations. As
of December 31, 2009, two customers’ account receivable balance accounted for 21% and 17% of the Company’s trade accounts
receivable balance. We believe that the risk with respect to trade receivables is mitigated by credit evaluations we perform on our
customers, the short duration of our payment terms for the significant majority of our customer contracts and by the diversification of our
customer base.
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Websites
We maintain the website, www.documentsecurity.com, which describes our patented document security solutions, our targeted
vertical markets, company history, and offers our security consulting services. We also maintain www.plasticprintingprofessionals.com,
which describes our ID card and other plastic and vinyl printing services. In addition, we maintain the website www.protectedpaper.com,
an e-commerce site that markets and sells our patented security papers hand-held security verifiers and custom security documents to
end users worldwide. We market digital and large offset commercial printing at our subsidiary website: www.dpirochester.com. In
addition, in February 2010, we acquired Premier Packaging, which maintains the website www.premiercustompkg.com. In addition to
the active websites, the company owns over 40 domain names for future use or for strategic competitive reasons.
Markets and Competition
Currently, the security print market is comprised of a few very large companies and an increasing number of small companies
with specific technology niches. The expansion of this market is the result of increasing requirements for national security, as well as the
proliferation of brand and identity theft. Counterfeiting has expanded significantly as advancing technologies in digital duplication and
scanning combined with increasingly sophisticated design software has enabled easier reproduction of originals.
Our industry is highly fragmented and characterized by rapid technological change and product innovations and evolving
standards. We feel a consolidation of the industry may transpire in the near future as larger, well financed companies acquire smaller
technology companies to position themselves in the industry to access their intellectual property and access to client lists. Many of our
current competitors have longer operating histories, more established products, greater name recognition, larger customer bases, and
greater financial, technical and marketing resources. As a result, our competitors may be able to adapt more quickly to new or emerging
technologies and changes in customer requirements, and devote greater resources to the promotion and sale of their
products. Competition may also force us to decrease the price of our products and services. There is no assurance that we will be
successful in developing and introducing new technology on a timely basis, new products with enhanced features, or that these products,
if introduced, will enable us to establish selling prices and gross margins at profitable levels.
Although our technology is effective primarily on analog and digital copiers and scanners, our competition covers a wide array of
document security and anti-counterfeiting solutions. We conduct research and development to improve our technology, including the
development of new patents and trade secrets. We will rely primarily upon our patents and trade secrets to attempt to thwart competition,
although there can be no assurance that we will be successful.
Our competitors include Standard Register Company, which specializes in printing security technologies for the check and forms
and medical industries; De La Rue Plc, that specializes in printing secure currency, tickets, labels, lottery tickets and vital records for
governments and Fortune 500 companies; Xerox, an industry leader in copying and scanning that has made recent entries into the anti-
counterfeiting business and has a competing Safety Paper product called “X Void.” Our P3 ID card manufacturing operation competes
with LaserCard Corporation which supplies advanced ID technology to the U.S. federal government and other government programs
worldwide, with a range of products and solutions that includes secure ID technologies.
In addition, other competing hidden word technologies are being marketed by competitors such as NoCopi Technologies which
sells and markets secure paper products, and Graphic Security Systems Corporation, which markets scrambled indicia.
Digital watermarks, RFID and biometric technologies are also being introduced into the marketplace by Digimarc Corporation,
IBM and L-1 Identity Solutions. These digital protection systems require software and hardware such as scanners and computers to
implement and utilize the technology and, consequently, this technology must be utilized in a controlled environment with the necessary
equipment to create the verification process. Versions of our optical security technologies do not require hardware and software to
operate and therefore provide a power outage fail-safe when combined or layered with RFID, digital watermarks or biometric systems.
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Large Office Equipment Manufacturers, called OEMs, such as Sharp, Canon, Ricoh, Hewlett Packard and Eastman Kodak are
developing “smart copier” technology that recognizes particular graphical images and produces warning words or distorted copies. Some
of the OEMs are also developing user assigned and variable pantograph “hidden word” technologies in which users can assign a
particular hidden word in copy, such as “void” that is displayed when copy of such document is made.
Optical deterrent features such as ours are utilized mainly by the large worldwide security printers for the protection of currency. Many of
these features such as micro-printing were developed pre-1980 as they were designed to be effective on the imaging devices of the day
which were mainly photography mechanisms. With the advent of modern day scanners, digital copiers, digital cameras and easy to use
imaging software such as Adobe Photoshop many of the pre-1980 optical deterrents such as micro-printing are no longer used or are
much less effective in the prevention of counterfeiting.
Unlike some of our competitors, our technologies are developed to defeat today’s modern imaging systems. Almost all of our products
and processes are built to thwart scanners and digital copiers and we believe that our products are the most effective in doing so in the
market today. In addition, our technologies do not require expensive hardware or software add-ons to authenticate a document, but
instead require simple, inexpensive hand-held readers which can be calibrated to particular hidden design features. Our technologies
are literally ink on paper that is printed with a particular method to hide selected things from a scanner’s “eye” or distort what a scanner
“sees.” These attributes make our anti-scanning technologies very cost effective versus other current offerings on the market since our
technologies are imbedded during the normal printing process, thereby significantly reducing the costs to implement the technologies.
The commercial printing industry in the US includes around 35,000 companies with $90 billion of annual revenue. (Source:
http://www.firstresearch.com/industryanalysis/commercialprinting.html). Several giants like RR Donnelley and Canadian printer
Quebecor World have multibillion revenues, but most printers considered "large" have annual revenues under $1 billion. The majority of
commercial printers are small or midsized businesses that operate one production plant, employ fewer than 20 people, and have annual
revenue under $5 million. Despite continuing consolidation, the industry is highly fragmented; the largest 50 companies hold only about
30 percent of the market. We compete primarily with locally-based printing companies in the Rochester and Western New York
markets. Most of our competitors in these markets are privately-held, single location operations.
In the packaging industry, we compete with a significant number of national, regional and local companies, many of which are
independent and privately-held. The largest competitors in this market are primarily focused on the long-run print order market. They
include large integrated paper companies such as Rock-Tenn Company, Caraustar Industries, Inc., Graphic Packaging Holding
Company and Mead Westvaco.
In general, changes in prevailing U.S. economic conditions significantly impact the general commercial printing industry. To the
extent weakness in the U.S. economy causes local and national corporations to reduce their spending on advertising and marketing
materials, the demand for commercial printing services may be adversely affected.
Employees
As of March 25, 2011, we had a total of 104 employees.. It is important that we continue to retain and attract qualified
management and technical personnel. Our employees are not covered by any collective bargaining agreement, and we believe that our
relations with our employees are good.
Government Regulation
In light of the events of September 11, 2001 and the subsequent war on terrorism, governments, private entities and individuals
have become more aware of, and concerned with, the problems related with counterfeit documents. Homeland Security remains a high
priority in the United States. This new heightened awareness may result in new laws or regulations which could impact our business. We
believe, however, that any such laws or regulations would be aimed at requiring or promoting anti-counterfeiting, and therefore would
likely have a positive impact on our business plans.
Document Security Systems plays an active role with the Document Security Alliance group, as it sits on various committees and
has been involved in design recommendations for important U.S. documents. This group of security industry specialists was formed by
the U.S. Secret Service to evaluate and recommend security solutions to the Federal government for the protection of credentials and
vital records.
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As counterfeiting continues to increase worldwide, various new laws and mandates are occurring to address the growing security
problem which we believe will increase our ability to generate revenue. For example, in 2007 Federal legislation was enacted that
required hospitals, physicians and pharmacies to use tamperproof paper to fill all Medicaid prescriptions. Initially, the requirement, which
was part 7002(b) of the “U.S. Troop Readiness, Veterans’ Care, Katrina Recovery and Iraq Accountability Appropriations Act of 2007”,
was effective April 1, 2008.
ITEM 1A – RISK FACTORS
Risks Related to Our Company
An investment in our securities is subject to numerous risks, including the Risk Factors described below. Our business, operating
results or financial condition could be materially adversely affected by any of the following risks. The risks described below are not the
only ones we face. Additional risks we are not presently aware of or that we currently believe are immaterial may also materially affect
our business. The trading price of our common stock could decline due to any of these risks. In assessing these risks, you should also
refer to the other information contained or incorporated by reference in this Form 10-K, including our financial statements and related
notes, competition and intellectual property disclosures.
We have a history of losses.
We have a history of losses. In fiscal 2010, 2009, and 2008, we incurred losses of approximately $4.6 million, $4.0 million, and
$8.3 million, respectively. Our results of operations in the future will depend on many factors, but largely on our ability to successfully
market our anti-counterfeiting products and services. Our failure to achieve profitability in the future could adversely affect the trading
price of our common stock and our ability to raise additional capital and, accordingly, our ability to continue to grow our business. There
can be no assurance that we will succeed in addressing any or all of these risks, and the failure to do so could have a material adverse
effect on our business, financial condition and operating results.
We have a significant amount of indebtedness and may be unable to satisfy our obligations to pay interest and principal
thereon when due.
As of December 31, 2010, we have the following approximate amounts of outstanding indebtedness:
(i)
$575,000 Promissory Note bearing interest at 10% per annum due November 24, 2012, secured by the assets of the
Company’s wholly owned subsidiary DPI.
(ii)
$583,000 due under a Credit Facility to a related party under which the Company can borrow up to $1,000,000 bearing interest
at LIBOR plus 2% per annum due January 4, 2012.
(iii)
$1,250,000 due under a Term Loan which matures March 1, 2013 and is payable in 35 monthly payments of $25,000 plus
interest commencing March 1, 2010 and a payment of $625,000 on the 36th month. Interest accrues at 1 Month LIBOR plus
3.75% and is secured by all of the assets of the Company’s subsidiary, Premier Packaging , which the Company acquired on
February 12, 2010. The Company subsequently entered into a interest rate swap agreement to lock into a 5.6% effective
interest rate over the life of the Term Loan. The Term Loan has also been guaranteed by Document Security Systems, and its
subsidiaries P3 and DPI.
(iv)
Up to $1,000,000 in a revolving line of credit available for use by Premier Packaging, subject to certain limitations which
matures on May 13, 2011(as amended) and is payable in monthly installments of interest only beginning on March 1, 2010.
Interest accrues at 1 Month LIBOR plus 3.75%, and is secured by all of the assets of the Company’s subsidiary, Premier
Packaging. As of December 31, 2010, there was approximately $615,000 outstanding on the line.
(v)
Up to $450,000 under a Standby Term Loan Note available to Premier Packaging for the funding of eligible equipment
purchases and is secured by all of the assets of the Company’s subsidiary, Premier Packaging. The Company has 12 months
to draw a line of credit, after which the balance of funds advanced from the line is converted into a 5 year term loan. Interest
accrues at LIBOR plus 3.00%. As of December 31, 2010, there was approximately $53,000 outstanding on the line.
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If we lose our current litigation, we may lose certain of our technology rights, which may affect our ability to sell certain of our
products and effectuate our business plan.
We are subject to litigation and threatened litigation, including without limitation our litigation with the ECB, in which parties
allege, among other things, that certain of our patents are invalid. If the ECB or other parties are successful in invalidating any or all of
our patents, it may materially affect us, our financial condition, and our ability to market and sell certain of our products based on any
patent that is invalidated. Furthermore, we have granted nearly all control over our ECB litigation to a third party, Trebuchet, who may or
may not have the resources or capabilities to successfully defend our patent rights or meet its financial obligations. If Trebuchet is
unable to meet its financial obligations, then we may be obligated to pay for certain court mandated legal costs to the ECB or other
parties, which may materially affect our financial condition.
If we are unable to adequately protect our intellectual property, our competitive advantage may disappear.
Our success will be determined in part by our ability to obtain United States and foreign patent protection for our technology and
to preserve our trade secrets. Because of the substantial length of time and expense associated with developing new document security
technology, we place considerable importance on patent and trade secret protection. We intend to continue to rely primarily on a
combination of patent protection, trade secrets, technical measures, copyright protection and nondisclosure agreements with our
employees and customers to establish and protect the ideas, concepts and documentation of software and trade secrets developed by
us. Our ability to compete and the ability of our business to grow could suffer if these intellectual property rights are not adequately
protected. There can be no assurance that our patent applications will result in patents being issued or that current or additional patents
will afford protection against competitors. We rely on a combination of patents, copyrights, trademarks and trade secret protection and
contractual rights to establish and protect our intellectual property. Failure of our patents, copyrights, trademarks and trade secret
protection, non-disclosure agreements and other measures to provide protection of our technology and our intellectual property rights
could enable our competitors to more effectively compete with us and have an adverse effect on our business, financial condition and
results of operations. In addition, our trade secrets and proprietary know-how may otherwise become known or be independently
discovered by others. No guarantee can be given that others will not independently develop substantially equivalent proprietary
information or techniques, or otherwise gain access to our proprietary technology.
In addition, we may be required to litigate in the future to enforce our intellectual property rights, to protect our trade secrets, to
determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such
litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, financial
condition or results of operations, and there can be no assurances of the success of any such litigation.
We may face intellectual property infringement or other claims against us, our customers or our intellectual property that could
be costly to defend and result in our loss of significant rights.
Although we have received patents with respect to certain technologies of ours, there can be no assurance that these patents will afford
us any meaningful protection. Although we believe that our use of the technology and products we developed and other trade secrets
used in our operations do not infringe upon the rights of others, our use of the technology and trade secrets we developed may infringe
upon the patents or intellectual property rights of others. In the event of infringement, we could, under certain circumstances, be required
to obtain a license or modify aspects of the technology and trade secrets we developed or refrain from using same. We may not have
the necessary financial resources to defend an infringement claim made against us or be able to successfully terminate any infringement
in a timely manner, upon acceptable terms and conditions or at all. Failure to do any of the foregoing could have a material adverse effect
on us and our financial condition. Moreover, if the patents, technology or trade secrets we developed or use in our business are deemed
to infringe upon the rights of others, we could, under certain circumstances, become liable for damages, which could have a material
adverse effect on us and our financial condition. As we continue to market our products, we could encounter patent barriers that are not
known today. A patent search will not disclose applications that are currently pending in the United States Patent Office, and there may
be one or more such pending applications that would take precedence over any or all of our applications.
Furthermore, third parties may assert that our intellectual property rights are invalid, which could result in significant expenditures
by us to refute such assertions. If we become involved in litigation, we could lose our proprietary rights, be subject to damages and incur
substantial unexpected operating expenses. Intellectual property litigation is expensive and time-consuming, even if the claims are
subsequently proven unfounded, and could divert management’s attention from our business. If there is a successful claim of
infringement, we may not be able to develop non-infringing technology or enter into royalty or license agreements on acceptable terms, if
at all. If we are unsuccessful in defending claims that our intellectual property rights are invalid, we may not be able to enter into royalty
or license agreements on acceptable terms, if at all. This could prohibit us from providing our products and services to customers, which
could have a material adverse effect on us and our financial condition.
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EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
The value of our intangible assets may not be equal to their carrying values.
As of December 31, 2010, we had approximately $3.8 million of net intangible assets, including goodwill. We are required to
evaluate the carrying value of such intangibles. Whenever events or changes in circumstances indicate that the carrying value of an
intangible asset, including goodwill, may not be recoverable, we determine whether there has been impairment by comparing the
anticipated undiscounted cash flows (discounted cash flows for goodwill) from the operation and eventual disposition of the product line
with its carrying value. If any of our intangible assets are deemed to be impaired then it will result in a significant reduction of the
operating results in such period. An impairment of patent acquisition costs of $377,000 was recognized in the fourth quarter of 2010 as a
result of adverse decisions in the Company’s patent infringement case against the ECB which caused the Company to reduce the
estimated cash flows that supported the Company’s capitalized patent acquisition based intangible asset.
Certain of our recently developed products are not yet commercially accepted and there can be no assurance that those
products will be accepted, which would adversely affect our financial results.
Over the past several years, we have spent significant funds and time to create new products by applying our technologies onto
media other than paper, including plastic and cardboard packaging, and delivered our technologies digitally. We have had limited
success in selling our products that are on cardboard packaging and those that are delivered digitally. Our business plan for 2011 and
beyond includes plans to incur significant marketing and sales costs for these newer products, particularly the digitally delivered
products. If we are not able to sell these new products, our financial results will be adversely affected.
The results of our research and development efforts are uncertain and there can be no assurance of the commercial success
of our products.
We believe that we will need to continue to incur research and development expenditures to remain competitive. The products we
currently are developing or may develop in the future may not be technologically successful. In addition, the length of our product
development cycle may be greater than we originally expect and we may experience delays in future product development. If our
resulting products are not technologically successful, they may not achieve market acceptance or compete effectively with our
competitors’ products.
Changes in document security technology and standards could render our applications and services obsolete.
The market for document security products, applications, and services is fast moving and evolving. Identification and
authentication technology is constantly changing as we and our competitors introduce new products, applications, and services, and
retire old ones as customer requirements quickly develop and change. In addition, the standards for document security are continuing to
evolve. If any segments of our market adopt technologies or standards that are inconsistent with our applications and technology, sales
to those market segments could decline, which could have a material adverse effect on us and our financial condition.
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EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
The market in which we operate is highly competitive, and we may not be able to compete effectively, especially against
established industry competitors with greater market presence and financial resources.
Our market is highly competitive and characterized by rapid technological change and product innovations. Our competitors may
have advantages over us because of their longer operating histories, more established products, greater name recognition, larger
customer bases, and greater financial, technical and marketing resources. As a result, they may be able to adapt more quickly to new or
emerging technologies and changes in customer requirements, and devote greater resources to the promotion and sale of their products.
Competition may also force us to decrease the price of our products and services. We cannot assure you that we will be successful in
developing and introducing new technology on a timely basis, new products with enhanced features, or that these products, if introduced,
will enable us to establish selling prices and gross margins at profitable levels.
Our growth strategy depends, in part, on our acquiring complementary businesses and assets and expanding our existing
operations to include manufacturing capabilities, which we may be unable to do.
Our growth strategy is based, in part, on our ability to acquire businesses and assets that are complementary to our existing
operations and expanding our operations to include manufacturing capabilities. We may also seek to acquire other businesses. The
success of this acquisition strategy will depend, in part, on our ability to accomplish the following:
·
·
·
·
identify suitable businesses or assets to buy;
complete the purchase of those businesses on terms acceptable to us;
complete the acquisition in the time frame we expect; and
improve the results of operations of the businesses that we buy and successfully integrate their operations into our own.
Although we were able to acquire our P3 subsidiary in February 2006, our DPI subsidiary in December 2008, and Premier
Packaging in February 2010, there can be no assurance that we will be successful in pursuing any or all of these steps on future
transactions. Our failure to implement our acquisition strategy could have an adverse effect on other aspects of our business strategy
and our business in general. We may not be able to find appropriate acquisition candidates, acquire those candidates that we find or
integrate acquired businesses effectively or profitably.
Our acquisition program and strategy may lead us to contemplate acquisitions of companies in bankruptcy, which entail
additional risks and uncertainties. Such risks and uncertainties include, without limitation, that, before assets may be acquired, customers
may leave in search of more stable providers and vendors may terminate key relationships. Also, assets are generally acquired on an “as
is” basis, with no recourse to the seller if the assets are not as valuable as may be represented. Finally, while bankrupt companies may
be acquired for comparatively little money, the cost of continuing the operations may significantly exceed expectations.
We have in the past used, and may continue to use, our common stock as payment for all or a portion of the purchase price for
acquisitions. If we issue significant amounts of our common stock for such acquisitions, this could result in substantial dilution of the
equity interests of our stockholders.
We may not realize the anticipated benefits of our recent acquisition of Premier Packaging.
Our expectations regarding the earnings, operating cash flow, capital expenditures and liabilities resulting from our recent
acquisition of Premier Packaging in February 2010 are based on information currently available to us and may prove to be incorrect. In
particular, 72% of Premier Packaging’s sales for the year ended December 31, 2009 were with two customers comprising 81% of
Premier Packaging’s accounts receivable balance as of December 31, 2009. As of December 31, 2010 one of the customers, which
accounted for 25% of the Company’s consolidated sales for 2010, has a contract with the Company that is currently set to expire in July
2011, and this customer also comprises 37% of the Company’s consolidated accounts receivable as of December 31, 2010. Our inability
to realize any of the anticipated benefits of this acquisition and to successfully integrate the acquired assets into our existing business will
have an adverse effect on our financial condition.
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If we fail to retain our key personnel and attract and retain additional qualified personnel, we might not be able to pursue our
growth strategy.
Our future success depends upon the continued service of our executive officers and other key sales and research personnel
who possess longstanding industry relationships and technical knowledge of our products and operations. The loss of any of our key
employees could negatively impact our ability to pursue our growth strategy and conduct operations. Although we believe that our
relationship with these individuals is positive, there can be no assurance that the services of these individuals will continue to be
available to us in the future. There can be no assurance that these persons will continue to agree to be employed by us after the
expiration dates of their current contracts.
If we do not successfully expand our sales force, we may be unable to increase our revenues.
We must expand the size of our marketing activities and sales force to increase revenues. We continue to evaluate various
methods of expanding our marketing activities, including the use of outside marketing consultants and representatives and expanding
our in-house marketing capabilities. If we are unable to hire or retain qualified sales personnel or if newly hired personnel fail to develop
the necessary skills to be productive, or if they reach productivity more slowly than anticipated, our ability to increase our revenues and
grow could be compromised. The challenge of attracting, training and retaining qualified candidates may make it difficult to meet our
sales growth targets. Further, we may not generate sufficient sales to offset the increased expense resulting from expanding our sales
force or we may be unable to manage a larger sales force.
Future growth in our business could make it difficult to manage our resources.
Our anticipated business expansion could place a significant strain on our management, administrative and financial resources.
Significant growth in our business may require us to implement additional operating, product development and financial controls, improve
coordination among marketing, product development and finance functions, increase capital expenditures and hire additional personnel.
There can be no assurance that we will be able to successfully manage any substantial expansion of our business, including attracting
and retaining qualified personnel. Any failure to properly manage our future growth could negatively impact our business and operating
results.
We cannot predict our future capital needs and we may not be able to secure additional financing.
We may need to raise additional funds in the future to fund our working capital needs, to fund more aggressive expansion of our
business, to complete development, testing and marketing of our products, or to make strategic acquisitions or investments. We may
require additional equity or debt financings, collaborative arrangements with corporate partners or funds from other sources for these
purposes. No assurance can be given that necessary funds will be available for us to finance our development on acceptable terms, if at
all. Furthermore, such additional financings may involve substantial dilution of our stockholders or may require that we relinquish rights
to certain of our technologies or products. In addition, we may experience operational difficulties and delays due to working capital
restrictions. If adequate funds are not available from operations or additional sources of financing, we may have to delay or scale back
our growth plans.
Risks Related to Our Industry
If we are unable to respond to regulatory or industry standards effectively, our growth and development could be delayed or
limited.
Our future success will depend in part on our ability to enhance and improve the functionality and features of our products and services in
accordance with regulatory or industry standards. Our ability to compete effectively will depend in part on our ability to influence and
respond to emerging industry governmental standards in a timely and cost-effective manner. If we are unable to influence these or other
standards or respond to these or other standards effectively, our growth and development of various products and services could be
delayed or limited.
Increased emphasis on expanding our marketing efforts to foreign countries subjects us to risks that are in addition to those to
which we are exposed in our domestic operations.
We believe that revenue from sales of products and services to commercial, governmental and other customers outside the United States
could represent a growing percentage of our total revenue in the future. International sales efforts are subject to a number of risks that
can adversely affect our sales of products and services to customers outside the United States, including:
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EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
·
·
·
·
·
·
·
·
changes in foreign government regulations and security requirements;
export license requirements, tariffs and taxes;
trade barriers;
difficulty in protecting intellectual property;
difficulty in collecting accounts receivable;
currency fluctuations;
longer payment cycles than those customary in the United States; and
political and economic instability.
We do not maintain operational infrastructure for international business. We depend on international business partners and
licensees for support of our international marketing efforts. These factors may result in greater risk of performance problems or of
reduced profitability with respect to our international sales efforts. In addition, if foreign customers, particularly foreign governmental
authorities, terminate or delay the implementation of our products and services, it may be difficult for us to generate profitable business in
these foreign jurisdictions.
Changes in the laws and regulations to which we are subject may increase our costs.
We are subject to numerous laws and regulations, including, but not limited to, environmental and health and welfare benefit regulations,
as well as those associated with being a public company. These rules and regulations may be changed by local, state, provincial,
national or foreign governments or agencies. Such changes may result in significant increases in our compliance costs. Compliance with
changes in rules and regulations could require increases to our workforce, and could result in increased costs for services, compensation
and benefits, and investment in new or upgraded equipment.
Declines in general economic conditions or acts of war and terrorism may adversely impact our business.
Demand for printing services are correlated with general economic conditions. The recent declines in U.S. economic conditions have
adversely impacted our business and results of operations, and may continue to do so for the foreseeable future. The overall business
climate of our industry may also be impacted by domestic and foreign wars or acts of terrorism, which events may have sudden and
unpredictable adverse impacts on demand for our products and services.
Risks Related to Our Stock
Provisions of our certificate of incorporation and agreements could delay or prevent a change in control of our company.
Certain provisions of our certificate of incorporation may discourage, delay, or prevent a merger or acquisition that a stockholder
may consider favorable. These provisions include:
·
·
the authority of the Board of Directors to issue preferred stock; and
a prohibition on cumulative voting in the election of directors.
We have a large number of authorized but unissued shares of common stock, which our management may issue without
further stockholder approval, thereby causing dilution of your holdings of our common stock.
As of December 31, 2010, there were approximately 180 million authorized but unissued shares of our common stock. Our management
continues to have broad discretion to issue shares of our common stock in a range of transactions, including capital-raising transactions,
mergers, acquisitions, for anti-takeover purposes, and in other transactions, without obtaining stockholder approval, unless stockholder
approval is required for a particular transaction under the rules of the NYSE Amex, New York law, or other applicable laws. If our Board
of Directors determines to issue additional shares of our common stock from the large pool of authorized but unissued shares for any
purpose in the future without obtaining stockholder approval, your ownership position would be diluted without your further ability to vote
on such transaction.
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The exercise of our outstanding options and warrants and vesting of restricted stock awards may depress our stock price.
As of December 31, 2010, we had outstanding stock options and warrants to purchase an aggregate of 2,767,131 shares of our
common stock at exercise prices ranging from $1.86 to $12.65 per share. This amount includes the warrants issued to Fletcher on
December 31, 2010 (as amended on February18, 2011 and March 14, 2011). These amounts do not include potentially issuable shares
under Fletcher’s Later Investment rights which provide Fletcher the right to acquire up to 756,387 shares of the Company’s common
stock at a price per share of $5.38 anytime prior to July 2, 2011. For each share purchased by Fletcher pursuant to the Later Investment,
Fletcher would receive a warrant to purchase an additional share of the Company’s commons stock at $5.38 for up to nine years. If
Fletcher exercises all of its Later Investment Rights, then an additional 756,387 warrants would be issued. (See Item 15 -Notes To The
Consolidated Financial Statements). This amount does includes 45,000 unvested restricted shares of our common stock that are subject
to various vesting terms. To the extent that these securities are converted into common stock, dilution to our stockholders will
occur. Moreover, the terms upon which we will be able to obtain additional equity capital may be adversely affected, since the holders of
these securities can be expected to exercise them at a time when we would, in all likelihood, be able to obtain any needed capital on
terms more favorable to us than the exercise and conversion terms provided by those securities.
Sales of these shares in the public market, or the perception that future sales of these shares could occur, could have the effect
of lowering the market price of our common stock below current levels and make it more difficult for us and our stockholders to sell our
equity securities in the future.
Sale or the availability for sale of shares of common stock by stockholders could cause the market price of our common stock to
decline and could impair our ability to raise capital through an offering of additional equity securities.
We do not intend to pay cash dividends.
We do not intend to declare or pay cash dividends on our common stock in the foreseeable future. We anticipate that we will
retain any earnings and other cash resources for investment in our business. The payment of dividends on our common stock is subject
to the discretion of our Board of Directors and will depend on our operations, financial position, financial requirements, general business
conditions, restrictions imposed by financing arrangements, if any, legal restrictions on the payment of dividends and other factors that
our Board of Directors deems relevant.
We have material weaknesses in our internal control over financial reporting structure, which, until remedied, may cause errors
in our financial statements that could require restatements of our financial statements and investors may lose confidence in
our reported financial information, which could lead to a decline in our stock price.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial
reporting as of the end of each year, and to include a management report assessing the effectiveness of our internal control over financial
reporting in each Annual Report on Form 10-K.
We have identified two material weaknesses in our internal control over financial reporting in our annual assessment of internal
controls over financial reporting that management performed for the year ended December 31, 2010. Management has concluded that
(i) we did not maintain a sufficient complement of qualified accounting personnel and controls associated with segregation of duties; and
(ii) we lack sufficient resources within the accounting department to have effective controls associated with identifying and accounting for
complex and non-routine transactions in accordance with U.S. generally accepted accounting principles, and that the foregoing
represented material weaknesses in our internal control over financial reporting. We are uncertain at this time of the costs to remediate
all of the above listed material weaknesses, however, we anticipate the cost to be in the range of $200,000 to $400,000 (including the
cost of hiring additional qualified accounting personnel to eliminate segregation of duties issues and using the services of accounting
consultants for complex and non-routine transactions if and when they arise). We cannot guarantee that the actual costs to remediate
these deficiencies will not exceed this amount. If our internal control over financial reporting or disclosure controls and procedures are
not effective, there may be errors in our financial statements and in our disclosure that could require restatements. Investors may lose
confidence in our reported financial information and in our disclosure, which could lead to a decline in our stock price.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal control over
financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only
reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect
the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Controls can be
circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls.
Over time, controls may become inadequate because changes in conditions or deterioration in the degree of compliance with policies or
procedures may occur. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may
occur and not be detected.
As a result, we cannot assure you that significant deficiencies or material weaknesses in our internal control over financial
reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we
encounter in their implementation, could result in significant deficiencies or material weaknesses, cause us to fail to timely meet our
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
periodic reporting obligations, or result in material misstatements in our financial statements. Any such failure could also materially
adversely affect the results of periodic management evaluations regarding disclosure controls and procedures and the effectiveness of
our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated
thereunder.
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EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
We may not meet the continued listing standards of the NYSE AMEX
In December 2008, we received a letter from the NYSE Amex stating that, based on the NYSE Amex’s review of publicly
available information, we were considered to be below the NYSE Amex’s continued listing standards. After submitting a plan of
compliance to the NYSE Amex and additional evaluation by the NYSE Amex, we were informed in March 2010 that we had resolved the
continued listing deficiencies.
On January 25, 2011, we received a warning letter from the NYSE Amex in connection with the Company's failure to secure
NYSE Amex approval for the additional issuances of our securities as required by Section 301 of the NYSE Amex Company Guide and
its continued listing standards. The listing deficiency involved three stock issuances totaling 1,235,153 shares made in November and
December of 2010. We thereafter filed our applications for the additional share listings with the NYSE Amex. On March 15, 2011, we
received notification from NYSE Amex that our additional listing applications have been approved, and that the Company has regained
full compliance with NYSE Amex listing requirements.
We cannot assure you that we will not receive additional deficiency letters in the future, or that we will continue to satisfy the
continued listing standards in order to remain listed on the NYSE Amex Equities exchange.
ITEM 2 - PROPERTIES
Our administrative offices are approximately 4,700 square feet and are located in the First Federal Plaza Building, 28 East Main
Street, Rochester, New York 14614 which we occupy under a lease that will expire in January 2012. Our plastic printing division leases
approximately 25,000 square feet in Brisbane, California in a lease that will expire in July 2014. DPI, our commercial printing group,
leases an approximately 20,000 square foot facility in Rochester, New York under a lease expiring in December 2013. We lease
approximately 40,000 square feet of production and warehouse space located in Victor, New York, a suburb of Rochester, from Bzdick
Properties, LLC, an entity owned by the former owner of Premier Packaging and the Company’s new President and Chief Operating
Officer, which will expire on February 12, 2020. We believe that our facilities are adequate for our current operations. The Company also
believes that it can negotiate renewals or similar lease arrangements on acceptable terms when our current leases expire.
ITEM 3 - LEGAL PROCEEDINGS
On August 1, 2005, the Company commenced a suit against the ECB alleging patent infringement by the ECB and claimed
unspecified damages. We brought the suit in the European Court of First Instance in Luxembourg. We alleged that all Euro banknotes in
circulation infringe the Company European Patent 0 455 750B1 which covers a method of incorporating an anti-counterfeiting feature
into banknotes or similar security documents to protect against forgeries by digital scanning and copying devices. The Court of First
Instance ruled on September 5, 2007 that it does not have jurisdiction to rule on the patent infringement claim, and also ruled that we will
be required to pay attorneys and court fees of the ECB. The ECB formally requested the Company to pay attorneys and court fees in the
amount of Euro 93,752 which, unless the amount is settled will be subject to an assessment procedure that has not been initiated, the
Company will accrue as soon as the assessed amount, if any, is reasonably estimable.
In 2006, the Company received notices that the ECB had filed separate claims in each of the United Kingdom, The Netherlands,
Belgium, Italy, France, Spain, Germany, Austria and Luxembourg courts seeking the invalidation of the Patent. Proceedings were
commenced before the national courts seeking revocation and declarations of invalidity of the Patent. On March 26, 2007, the High
Court of Justice, Chancery Division, Patents Court in London, England ruled that the Patent was deemed invalid in the United Kingdom,
and on March 19, 2008 this decision was upheld on appeal. As a result of these decisions, the Company was notified of the final
assessment of the reimbursable ECB costs for both court cases was ₤356,490, of which all was paid as of December 31, 2010.
On March 27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled that the German part of the Patent was
valid, having considered the English Court’s decision. On July 6, 2010, the Company was notified that the German Court has ruled that
the Patent, that was awarded to the Company by the European Patent Office and upheld as valid in a previous hearing in the German
Court of First Instance, has now been deemed invalid in Germany due to added matter. On January 9, 2008 the French Court held that
the Patent was invalid in France for the same reasons given by the English Court. The Company filed an appeal against the French
decision on May 7, 2008. On March 20, 2010, the Company was informed that the decision was upheld in the French appeal. On March
12, 2008 the Dutch Court ruled that the Patent is valid in the Netherlands. The ECB filed an appeal against the Dutch decision on
March 27, 2008. The Dutch appeal was heard in June 2010, and the Company was notified on December 21, 2010 that the patent was
deemed invalid upon appeal. On November 3, 2009, the Belgium Court held that the Patent was invalid in Belgium for the same reasons
given by the English and French courts as were similarly informed by the Austrian court on November 17, 2009. Cost reimbursement, if
any, associated with the Belgium, Austrian, and French validity cases as well as the appeals in Germany and France are covered under
the Trebuchet agreement described below. On March 24, 2010 the Spanish Court ruled that the Patent was valid. In Italy the validity
case is to be heard again by a newly appointed judge expected during 2011 and a hearing in Luxembourg thereafter.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
14
On August 20, 2008, the Company entered into an agreement with Trebuchet under which Trebuchet agreed to pay substantially
all of the litigation costs associated validity proceedings in eight European countries relating to the Patent. Trebuchet also agreed to pay
substantially all of the litigation costs associated with any future validity challenges filed by the ECB or other parties, provided that
Trebuchet elects to assume the defense of any such challenges, in its sole discretion, and patent infringement suits filed against the ECB
and certain other alleged infringers of the Patent, all of which suits may be brought at the sole discretion of Trebuchet and may be in the
name of the Company, Trebuchet or both. The Company provided Trebuchet with the sole and exclusive right to manage infringement
litigation relating to the Patent in Europe, including the right to initiate litigation in the name of the Company, Trebuchet or both and to
choose whom and where to sue, subject to certain limitations set forth in the agreement under the terms of the Agreement, and in
consideration for Trebuchet's funding obligations, the Company assigned and transferred a 49% interest of the Company's rights, title
and interest in the Patent to Trebuchet which allows Trebuchet to have a separate and distinct interest in and share of the Patent, along
with the right to sue and recover in litigation, settlement or otherwise to collect royalties or other payments under or on account of the
Patent. In addition, the Company and Trebuchet have agreed to equally share all proceeds generated from litigation relating to the
Patent, including judgments and licenses or other arrangements entered into in settlement of any such litigation. Trebuchet is also
entitled to recoup any litigation expenses specifically awarded to the Company in such actions.
The Patent has been confirmed to be valid and enforceable in one jurisdiction (Spain) that uses the Euro as its national currency
allowing the Company or Trebuchet, on the Company’s behalf, to proceed with infringement cases in Spain if we choose to do so. On
February 18, 2010, Trebuchet, on behalf of the Company, filed an infringement suit in the Netherlands against the ECB and two security
printing entities with manufacturing operations in the Netherlands, Joh. Enschede Banknotes B.V and Koninklijke Joh. Enschede B.V.
Upon determination on December 21, 2010, that the patent was invalid in the Netherlands, the infringement case will not be continued.
On January 31, 2003, the Company commenced an action, unrelated to the above ECB litigation, entitled New Sky
Communications, Inc., As Successor-In-Interest To Thomas M. Wicker, Thomas M.Wicker Enterprises, Inc. and Document Security
Consultants V. Adler Technologies, Inc. N/K/A Adlertech International, Inc. and Andrew McTaggert (United States District Court, Western
District Of New York Case No.03-Cv-6044t(F)) regarding certain intellectual property in which the Company has an interest. On
December 7, 2009, the Company reached an agreement to terminate all litigation in association with this suit. In conjunction with that
agreement, the Company issued to the opposing parties an aggregate of 40,000 shares of common stock valued at approximately
$85,000 and 50,000 of common stock warrants for the purchase of common shares at $3.00 per share valued at approximately $30,000
utilizing the Black Scholes pricing model. The Company recorded an expense related to the estimated grant date fair value of the shares
and warrants issued of approximately $115,000. In addition, both parties agreed not to compete with certain of the other party’s
customers for 7 years. The Company does not believe that the competition agreement will have a material impact on its business.
There are no other material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of its
property is subject, other than ordinary routine litigation incidental to the Company’s business.
15
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
PART II
ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF
EQUITY SECURITIES
Our Common Stock is listed on the NYSE Amex, where it trades under the symbol “DMC.”
The following table sets forth the high and low closing prices for the shares of our Common Stock, for the periods indicated.
QUARTER ENDING
March 31, 2010
June 30, 2010
September 30, 2010
December 31, 2010
QUARTER ENDING
March 31, 2009
June 30, 2009
September 30, 2009
December 31, 2009
$
$
$
$
HIGH
4.41
3.94
4.01
5.51
HIGH
1.92
2.24
2.45
3.14
LOW
2.44
2.70
3.04
3.38
LOW
1.59
1.63
1.86
1.95
The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual
transactions.
From January 1, 2011 through March 25, 2011, our common stock had a high closing price of $5.58 and a low closing price of
$4.48.
Issued and Outstanding
Our certificate of incorporation authorizes 200,000,000 shares of common stock, par value $0.02. As of March 25, 2011, we had
19,498,884 shares of common stock issued and outstanding.
Equity Compensation Plan Information
The following table provides certain information as of December 31, 2010 with respect to our equity compensation plans.
Number of
securities to
be issued
upon
exercise of
outstanding
options,
warrants
and rights
Weighted
average
exercise price
of
outstanding
options,
warrants and
rights
Restricted
stock
to be issued
upon
vesting
Number of
securities
remaining
available for
future
issuance
(under equity
compensation
Plans
(excluding
securities
reflected in
column (a &
b))
Plan Category
(a)
(b)
(c)
(d)
Equity compensation plans approved by security holders
2004 Employee Stock Option Plan
2004 Non-Executive Director Stock Option Plan
Equity compensation plans not approved by security holders
Contractual warrant grants for services
Total
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
45,000
673,500
157,000
$
-
376,760
45,000
1,207,260
$
6.09
5.61
6.65
5.96
846,481
43,000
-
889,481
16
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Recent Issuances of Unregistered Securities.
There were no issuances of unregistered securities sold by the Company that have not been previously reported in the Company’s
Current Reports on Form 8-K.
Stockholders
As of March 24, 2011, we had approximately 919 record holders of our common stock. This number does not include the number of
persons whose shares are in nominee or in “street name” accounts through brokers.
Dividends
On September 23, 2010, our Board of Directors declared a non-monetary dividend pursuant to which we distributed to our
stockholders of record on October 8, 2010 on a pro-rata basis an aggregate of 7,500,000 shares of common stock of Internet Media
Services. The dividend was recorded at approximately $229,000 which was the book value of the investment as of September 23,
2010. We did not pay dividends during 2009. We presently intend to retain our cash for use in the operation and expansion of our
business and, therefore, do not anticipate paying any cash dividends in the foreseeable future.
Shares Repurchased by the Registrant
We did not purchase or repurchase any of our securities in the fiscal year ended December 31, 2010, including the fourth
quarter.
The information required by Item 201(d) of Regulation S-K will be contained in our Proxy Statement for our Annual Stockholders
Meeting, which we will file with the Securities and Exchange Commission within 120 days after December 31, 2010, and which is
incorporated by reference herein.
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
Forward-looking statements in this Annual Report, including without limitation, statements related to the Company’s plans,
strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act and contain the words “believes,” “anticipates,” “expects,” “plans,” “intends” and similar words and
phrases. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from
the results projected in any forward-looking statement. In addition to the factors specifically noted in the forward-looking statements, other
important factors, risks and uncertainties that could result in those differences include, but are not limited to, those discussed under Part
I, Item 1A “Risk Factors” in this Annual Report. The forward-looking statements are made as of the date of this Annual Report, and we
assume no obligation to update the forward-looking statements, or to update the reasons why actual results could differ from those
projected in the forward-looking statements. Investors should consult all of the information set forth in this report and the other
information set forth from time to time in our reports filed with the Securities and Exchange Commission pursuant to the Securities
Exchange Act of 1934, including our reports on Forms 10-Q and 8-K.
The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in
Item 8 of this Annual Report.
Overview
Document Security Systems markets and sells products designed to protect valuable information from unauthorized scanning,
copying, and digital imaging. We have developed security technologies that are applied during the normal printing process and by all
printing methods including traditional offset, gravure, flexo, digital or via the internet on paper, plastic, or packaging. Our technologies
and products are used by federal, state and local governments, law enforcement agencies and are also applied to a broad variety of
industries as well, including financial institutions, high technology and consumer goods, entertainment and gaming,
healthcare/pharmaceutical, defense and genuine parts industries. Our customers use our technologies where there is a need for
enhanced security for protecting and verification of critical financial instruments and vital records, or where there are concerns of
counterfeiting, fraud, identity theft, brand protection and liability.
17
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We have developed or acquired over 30 technologies that provide to our customers a wide spectrum of solutions. We hold
numerous patents, patent pendings, trademarks and trade secrets that form the basis of our security technology offerings. Our
competitive position in the security printing market is based largely on our attention to the research and development of technologies,
ideas and know-how that combat a widening range of copying, scanning and other duplication devices that exist in today’s market that
can be used for counterfeiting and unauthorized duplication of sensitive information and images. We sell our products under the
AuthentiGuard® name generally in the following ways: (a) as generic products, including safety paper and plastic cards geared for the
end user market for printed security products; (b) as custom printed products; (c) as technology licenses; or (d) as customized digital
implementations.
Prior to 2006, the Company’s primary revenue source in its document security division was derived from the licensing of its
technology. The Company had limited production capabilities. In 2006, the Company began to expand our ability to be a provider of
anti-counterfeiting products that utilize our anti-counterfeiting technologies. In 2006, we acquired P3, a privately held plastic cards
manufacturer located in the San Francisco, CA area. P3’s primary focus is manufacturing long-life composite, laminated and surface
printed cards which can include magnetic stripes, bar codes, holograms, signature panels, invisible ink, micro fine printing, guilloche
patterns, Biometric, RFID and a patent-pending watermark technology. P3’s products are marketed through an extensive broker network
that covers much of North America, Europe and South America and by manufacturing for various industry integrators.
In December 2008, we acquired substantially all of the assets of DPI of Rochester, LLC, a privately held commercial printer
located in Rochester, NY. We formed DPI to incorporate this new company which significantly improved our ability to produce our
security paper products as well as improving our competitiveness in the market for custom security printing, especially in the areas of
vital records, secure coupons, transcripts, and prescription paper along with the ability to offer our customers a wider range of
commercial printing offerings.
In February 2010, the Company acquired Premier Packaging, a privately held packaging company located in the Rochester NY
area. Premier Packaging is an ISO 9001:2008 registered manufacturer of custom paperboard packaging serving clients in the
pharmaceutical, beverage, photo packaging, toy, specialty foods and direct marketing industries, among others. The Company expects
the acquisition will allow it to introduce anti-counterfeiting products to the packaging market that further expands the usage of its
technologies. The Company believes that the ability to deter and prevent counterfeiting of brand packaging will provide major benefits to
companies around the globe who are affected by product counterfeiting.
In the past few years, we have divested two operations so that we could focus our efforts on security and commercial
printing. During 2007, we sold the assets of our retail printing and copying division, called Patrick Printing. In October 2009, we sold the
assets and liabilities associated with Legalstore in exchange for 7,500,000 shares of common stock of Internet Media Services. In
October 2010, we distributed our shares of Internet Media Services in the form of a dividend to our shareholders.
RESULTS OF OPERATIONS FOR THE FISCAL YEARS ENDED DECEMBER 31, 2010 AND 2009
The following discussion and analysis provides information that our management believes is relevant to an assessment and
understanding of our results of operations and financial condition. In October 2009, the Company sold Legalstore. In accordance with
FASB ASC 205-20-45, the Company reported the results of Legalstore as continued operations because the operations and cash flows
of the component have not been eliminated given the Company’s continued involvement after the sale as a shareholder in Internet Media
Services, the purchaser of Legalstore. In October 2010, we distributed our shares of Internet Media Services in the form of a dividend to
our shareholders. In February 2010, we acquired Premier Packaging, a $7,000,000 packaging company based in Victor, NY,
approximately 17 miles from Rochester, NY, our headquarters. The discussion should be read in conjunction with the financial
statements and footnotes that appear elsewhere in this report.
18
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Revenue
Revenue
Security and commercial printing
Packaging
Technology license royalties and digital solutions
Legal products
Total Revenue
Year Ended
December
31,
2010
Year Ended
December
31,
2009
% change
$ 6,988,000
5,753,000
641,000
-
$ 13,382,000
$ 8,773,000
-
783,000
355,000
$ 9,911,000
(20)%
-
(18)%
(100)%
35%
Revenue - Revenue in 2010 increased 35% from 2009. Security and commercial print sales decreased 20%, primarily due to
decreases in commercial printing orders from the Company’s DPI division. The Company experienced lower orders from certain
customers as a result of the change in the Company’s market focus. Generally, the Company is seeking to reduce its overall commercial
printing business and focus more of its printing on security printing opportunities. Furthermore, the Company utilized a portion of it press
time on printing for its newly acquired packaging company, which resulted in lower external print sales. Packaging sales were $5.8
million for the ten and one-half-month period from February 12, 2010 to December 31, 2010. During 2010, the Company focused on
streamlining operations between its security printing, commercial printing and packaging division to strengthen its competitive position in
the markets it sells to and generate cost savings and synergies. During 2010, the Company had approximately $936,000 as opposed to
$212,000 in 2009 of intercompany sales which were eliminated for consolidated reporting.
The Company’s technology license revenue declined 18% as usage by its largest licensee declined. The Company continues to
seek long-term licensing partners, however, we primarily focus our sales and business development efforts on end-user solutions for our
customers. Furthermore, during 2010, the Company did not have any legal product sales as this division was sold in October 2009.
Gross profit
Costs of revenue
Security and commercial printing
Packaging
Technology license royalties and digital solutions
Legal products
Total cost of revenue
Gross profit
Security and commercial printing
Packaging
Technology license royalties and digital solutions
Legal products
Total gross profit
19
Year Ended
December
31,
2010
Year Ended
December
31,
2009
% change
$ 5,304,000
4,387,000
5,000
-
9,696,000
$ 6,063,000
-
14,000
179,000
6,256,000
1,684,000
1,366,000
636,000
-
$ 3,686,000
2,710,000
-
769,000
176,000
$ 3,655,000
(13)%
-
(64)%
(100)%
55%
(38)%
-
(17)%
(100)%
1%
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Year Ended
December
31,
2010
Year Ended
December
31,
2009
% change
Gross profit percentage:
28%
37%
(24)%
Gross Profit - Gross profit was flat between 2010 and 2009, which was primarily due to the significant decrease in the gross
profits generated from the Company’s security and commercial printing as a result of decreases in sales at the Company’s commercial
printing division, which more than offset the increase in gross profits as a result of the Company’s packaging division which the Company
acquired in February 2010. In addition, the Company did not have any gross profits from legal product sales as the division was sold in
the fourth quarter of 2009. The Company’s gross profit percentage decrease for 2010 as compared to 2009 reflects the larger weight
that packaging sales, which typically carry a lower gross profit margin, have on the Company’s overall revenue areas, along with the
weakness in commercial printing sales. The Company expects that the impact of the Company’s acquisition of it packaging division will
be to decrease overall gross profit margins for at least the near future, especially as the number of non-security packaging projects out-
number the security packaging projects, which the Company expects will be at higher profit margins.
Operating Expenses
Operating Expenses
Sales, general and administrative compensation
Professional Fees
Sales and marketing
Research and development
Rent and utilities
Other
Other Operating Expenses
Depreciation and software amortization
Stock based compensation
Impairment of patents
Amoritization of intangibles
Year Ended
December
31, 2010
Year Ended
December
31, 2009 % change
$ 3,431,000
603,000
238,000
265,000
659,000
642,000
5,838,000
$ 3,638,000
539,000
154,000
292,000
477,000
710,000
5,810,000
140,000
423,000
377,000
803,000
1,743,000
148,000
68,000
-
1,342,000
1,558,000
(6)%
12%
55%
(9)%
38%
(10)%
0%
(5)%
522%
-
(40)%
12%
Total Operating Expenses
$ 7,581,000 $ 7,368,000
3%
Sales, general and administrative compensation costs were 6% lower in 2010 as compared to 2009, which reflects the impact of
the addition of approximately $634,000 of SG&A compensation expense from the packaging division the Company acquired in February
2010. Otherwise, SG&A compensation costs would have decreased 23% during 2010 as compared to 2009 as the result of staff
reductions made by the Company throughout 2009 and in early 2010 primarily in its commercial printing division.
20
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Professional fees in 2010 increased 12% in 2010 due to increases in legal fees primarily associated with legal costs associated
with the Company’s various business development and contractual activities, along with an increase in consulting costs. In February of
2011, the Company hired an in-house General Counsel in an effort to reduce its overall legal costs in 2011 and beyond.
Sales and marketing costs during 2010 increased 55% from 2009 due to sales and marketing at the Company’s Premier
Packaging division as well as an increase in marketing efforts and trade show participation for its security printing and plastic printing
divisions in 2010 based on expectations that the sales downturn the Company had experienced during the global recession was
reversing.
Research and development costs consist primarily of compensation costs for research personnel and direct costs for the use of
third-party printers’ facilities to test our technologies on equipment that we do not have access to internally. Research and development
costs decreased due to a reduction in compensation cost.
Rent and utilities increased as a result of the acquisition of Premier Packaging in February 2010.
Other operating expenses are primarily equipment maintenance and repairs, office supplies, IT support, bad debt expense and
insurance costs. During 2010, these costs decreased 10% which was primarily the result of a one time write off of previously accrued
estimated expenses of approximately $139,000 that were never incurred and a write off of previous accrued expenses that never
transpired. This more than offset increases in other expenses of $171,000 associated with the Company’s packaging division, which
the Company acquired in February 2010.
Stock based compensation expense in 2010 was $423,000 as compared to $68,000 of stock based compensation expense in
2009 which reflected the effect of reversals of previously recorded stock based compensation expense for stock options and restricted
shares issued to the Company’s employees which terminated unvested due to employee terminations that occurred during the first
quarter of 2009. The 2010 stock based compensation expense included options granted to employees at Premier Packaging when the
Company acquired it in February 2010, and to certain senior management, along with stock based compensation expense related to
warrants issued to third parties for consulting services.
Impairment of patent acquisition costs of $377,000 was recognized in the fourth quarter of 2010 as a result of adverse decisions
in the Company’s patent infringement case against the ECB which caused the Company to reduce the estimated cash flows that
supported the Company’s capitalized patent acquisition based intangible asset.
Amortization of intangibles expense decreased in 2010, as compared to the 2009 as a result of the reduction in the Company’s
net capitalized patent acquisition and defense costs asset, partially offset by increases in amortization of other intangible expense of new
other intangibles acquired during the Company’s acquisition of Premier Packaging in February 2010.
Other Income and expenses
Other income (expense):
Interest income
Interest expense
Amortizaton of note discount
Loss in equity investment
Gain on deconsolidation of Legalstore.com division
Gain on foreign currency transactions
Litigation settlements
Registration rights penalties
Other income
Year Ended
December
31,
2010
Year Ended
December
31,
2009
% change
$
-
$
(290,000)
(420,000)
(121,000)
-
-
-
-
143,000
18,000
(259,000)
(250,000)
-
26,000
15,000
(115,000)
(109,000)
416,000
(100)%
12%
68%
-
(100)%
(100)%
100%
100%
(66)%
Other expense, net
$
(688,000) $
(258,000)
167%
21
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Interest expense: During 2010, interest expense increased as a result of the increased debt carried by the Company due to its
use of a term note to help fund the Company’s acquisition of Premier Packaging in February 2010 along with the use of a revolving line of
credit to fund the working capital needs of Premier Packaging.
Amortization of note discount: During 2009, the Company entered into two convertible notes that had conversion features at
below fair value and therefore, a beneficial conversion feature. Accordingly, the Company determined that a total of approximately
$423,000 of note discount had been created as a result of the beneficial conversion features and a warrant issued with the debt. The
Company was amortizing this expense over the expected life of the convertible notes. On November 29, 2010, the holder exercised the
conversion feature of the $350,000 Convertible Note for 218,750 shares of common stock, par value $0.02 which retired the debt in
full. In conjunction with the conversion, the Company recognized approximately $63,000 of note discount expense. On December 24,
2010, the holder of the note exercised the conversion feature of the $450,000 Convertible Note for 260,116 shares of common stock, par
value $0.02 which retired the debt in full. In conjunction with the conversion, the Company recognized approximately $200,000 of note
discount expense.
During 2009, the Company also recognized the amortization of note discount expense of approximately $247,000 for warrants
that were issued in conjunction with the secured promissory note which had a fair value of approximately $256,000.
Gain on deconsolidation of Legalstore division: In October 2009, the Company sold Legalstore for a non-controlling interest
(37% ownership interest) in Internet Media Services. The Company recognized a gain on the transaction of approximately $26,000 as
the estimated fair value of consideration received in exchange for the assets and liabilities sold exceeded the Company’s book value of
the assets and liabilities.
The Company accounted for the deconsolidation of the business by recognizing a gain in net income, measured as the
difference between: the fair value of the consideration received, which in the Company’s case was a 37% equity interest in Internet
Media Services over the book value of the assets and liabilities transferred. The Company determined that the consideration received
was not readily measurable because there was no activity in Internet Media Services shares prior to the transaction. Therefore, the
Company determined that the value of the “business transferred” was more readily measurable by determining the fair value utilizing a
discounted cash flow model.
Loss in equity investment: The Company recognized gains or losses on its investment in Internet Media Services, the entity that
purchased Legalstore from the Company in October 2009 under the equity method of accounting for investments. During 2010, the
Company recorded a cumulative loss in its investment of $121,000. On September 23, 2010, the Company’s Board of Directors
declared a dividend pursuant to which the Company distributed to its stockholders of record on October 8, 2010 on a pro-rata basis an
aggregate of 7,500,000 shares of common stock of Internet Media Services. As a result, the Company has recorded a dividend of
approximately $229,000 which was the book value of the investment as of September 23, 2010.
Litigation settlements: On December 7, 2009, the Company reached an agreement to issue 40,000 shares of common stock
valued at approximately $86,000 and 50,000 of common stock warrants valued at approximately $30,000 utilizing the Black Scholes
option pricing model, for the purchase of common shares at $3.00 per share in connection with the settlement of certain litigation
between the Company and the recipients. The shares and common stock warrants were recorded at the aggregate estimated fair value
of $115,000.
Registration Rights Penalties: During 2009, the Company recorded expense of approximately $109,000 for the fair value of
warrants to purchase 40,000 shares of common stock at $2.00 issuable to Printer’s LLC as a result of the Company’s failure to file a
registration statement under the terms of the $450,000 Convertible Note issued by the Company in December 2009.
Other Income: The Company received $143,000 during 2010 and $416,000 during 2009 for New York State Qualified Emerging
Technology Company (“QETC”) refundable tax credits for the tax years ended 2008, 2007, 2006, and 2005.
22
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Net loss and loss per share
Net loss
Year Ended
December
31,
2010
Year Ended
December
31,
2009
% change
$ (4,604,000) $ (3,990,000)
15%
Net loss per share, basic and diluted
$
(0.26) $
(0.27)
Weighted average common shares outstanding, basic and diluted
17,755,141 14,700,453
(4)%
21%
Net loss and loss per share -
During 2010, the Company experienced a net loss of $4.6 million, a 15% increase from the net loss of 2009. The increase
reflects the impact of certain non-recurring items such as the impairment asset charge of $377,000 the Company recorded in the fourth
quarter of 2010, $263,000 of accelerated note discount expense recorded by the Company as a result of the conversion of certain debt
instruments, and a significant increase in stock based compensation as compared to 2009. In addition, in 2009, the Company had
significant non-recurring income associated with the receipt of tax credits. Furthermore, in 2010, the Company acquired Premier
Packaging, which increased the non-cash depreciation expense and amortization expense, as the result of the recognition of the fair
value of equipment and intangible assets acquired, by approximately $299,000.
Liquidity and Capital Resources
The Company’s cash flows and other key indicators of liquidity are summarized as follows:
Year Ended
December 31,
2010
Year Ended
December 31,
2009
% change
vs.
2009
Cash flows from:
Operating activities
Investing activities
Financing activities
Working capital
Current ratio
$ (1,759,000)
(2,427,000)
7,824,000
3,003,000
$ (1,595,000)
(108,000)
2,064,000
(818,000)
1.72 ☑
0.70 ☑
Cash and cash equivalents
Funds Available from Open Credit Facilities
Debt (excluding unamortized debt discount) and Capitalized Leases
$ 4,087,000
$
802,000
$ 3,263,000
449,000
$
$
417,000
$ 2,218,000
(10)%
(2,147)%
279%
467%
147%
810%
92%
47%
We have historically met our liquidity and capital requirements primarily through the private placement of equity securities and
debt financings. As of December 31, 2010, we had cash and cash equivalents of $4,087,000 representing an 810% increase over our
December 31, 2009 cash position of $449,000. The increase in the Company’s cash position was due to the $4,000,000 sale of equity to
Fletcher that the Company made on December 31, 2010.
23
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Operating Cash Flow – During 2010, the Company used approximately $1.8 million of cash for operations, a 10% increase from
our use of cash for operations in 2009, which generally reflected the Company’s paydown of accounts payables and accrued expenses
and timing of cash flows from its Packaging division, which received approximately $300,000 in cash payments from customers in early
January 2011 that otherwise would have reflected an improvement in operating cash flows in 2010 as compared to 2009.
Investing Cash Flow - During 2010, the Company used approximately $2.0 million for the acquisition of Premier Packaging. The
Company made the acquisition of Premier Packaging as part of the implementation of its long-term strategy to increase its ability to offer
end-user customers of secure documents and related product, with brand protection packaging specifically targeted with the Premier
Packaging acquisition. In addition, the Company spent approximately $427,000 on equipment additions and patent related costs. As
the Company becomes more of a manufacturer of security products, it expects to continue to see an increase in its capital expenditures
for plant and equipment. In addition, as the Company continues to focus on the research and development of anti-counterfeiting
technologies, techniques and products, it anticipates continuing to spend capital on patents.
Financing Cash Flows - During 2010, the Company raised net proceeds through the sale of equity of approximately $6.3 million,
of which approximately $3.8 million was raised on December 31, 2010. Proceeds from these equity sales were used to provide some of
the funding for an acquisition, make investments in fixed assets and in the Company’s patent portfolio, and to fund working capital. In
addition, the Company borrowed $1,500,000 on a five year term note to fund its acquisition of Premier Packaging in February 2010. As
of December 31, 2010, the Company had approximately $4,087,000 in cash, primarily the result of its equity funding.
Future Capital Needs - As of December 31, 2010, the Company has approximately $4,087,000 in cash and $417,000 available
to it under one credit facility, along with up to $385,000 available under a credit line at its Premier Packaging subsidiary. While the
Company’s working capital position has significantly improved since December 31, 2009, the Company continued to incur operating
losses during 2010, and therefore the Company will likely use its cash on hand to fund its operations until it can consistently generate
positive cash flow from its operations. In addition, the Company has approximately $3.3 million of debt, of which approximately $1 million
is current, which may require the use of its cash on hand in order to pay. While the Company believes that its cash on hand will provide
it sufficient resources in order to fund its operations and meet its obligations for at least the next twelve months, if the Company cannot
generate sufficient cash from its operations in the future, the Company may need to raise additional funds in order to fund its working
capital needs and pursue its growth strategy.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, an effect on our financial
condition, financial statements, revenues or expenses.
Inflation
Although our operations are influenced by general economic conditions, we do not believe that inflation had a material effect on
our results of operations during 2010 or 2009 as we are generally able to pass the increase in our material and labor costs to our
customers, or absorb them as we improve the efficiency of our operations.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the
United States requires management to make judgments, assumptions and estimates that affect the amounts reported in our consolidated
financial statements and accompanying notes. The consolidated financial statements for the fiscal year ended December 31, 2010
describe the significant accounting policies and methods used in the preparation of the consolidated financial statements. Estimates are
used for, but not limited to, the accounting for the allowance for doubtful accounts and sales returns, goodwill impairments, inventory
allowances, revenue recognition, stock based compensation valuations, the valuation of intangible assets, and allocation of assets in
business combinations. Actual results could differ from these estimates. The following critical accounting policies are impacted
significantly by judgments, assumptions and estimates used in the preparation of our consolidated financial statements.
Long Lived Assets
The Company reviews long-lived assets and certain identifiable intangibles for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Fair value is determined based on discounted cash flows or appraised values,
depending on the nature of the assets.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
24
Fixed assets are carried at cost. Depreciation is computed over the estimated useful life of five to seven years using the straight-
line depreciation method. Leasehold improvements are amortized over the shorter of their useful life or the lease term. Intangible assets
consist primarily of royalty rights, contractual rights, customer list, and patent acquisition, application and defense costs. Amortization is
computed over the estimated useful life of five to twenty years using the straight-line depreciation method. For patent related assets,
the remaining legal life of the patent is used as the estimate useful life unless circumstances determine that the useful life will be less
than the legal life. Long-lived assets to be held and used by the Company are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable. We periodically evaluate the recoverability of our
long-lived assets based on estimated future cash flows from and the estimated fair value of such long-lived assets, and provide for
impairment if such undiscounted cash flows are insufficient to recover the carrying amount of the long-lived asset.
Goodwill
Goodwill is the excess of cost of an acquired entity over the fair value of amounts assigned to assets acquired and liabilities
assumed in a business combination. Goodwill is not amortized, rather it is tested for impairment annually, and will be tested for
impairment between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be
impaired. Impairment testing for goodwill is done at a reporting unit level. Reporting units are one level below the business segment
level, but are combined when reporting units within the same segment have similar economic characteristics. The Company has three
reporting units with goodwill based on the current structure. An impairment loss generally would be recognized when the carrying
amount of the reporting unit’s net assets exceeds the estimated fair value of the reporting unit. The Company completed its assessment
of any potential impairment upon adoption of this standard and performs annual assessments.
Other Intangible Assets and Patent Defense Costs
Other intangible assets consists of costs associated with the application, acquisition and defense of the Company’s patents,
contractual rights to patents and trade secrets associated with the Company’s technologies, a non-exclusive licensing agreement, and
customer lists obtained as a result of acquisitions. The Company’s patents and trade secrets are for document anti-counterfeiting and
anti-scanning technologies and processes that form the basis of the Company’s document security business. Patent application costs
are capitalized and amortized over the estimated useful life of the patent, which generally approximates its legal life. External legal costs
incurred to defend the Company’s patents are capitalized to the extent of an evident increase in the value of the patents and an expected
successful outcome. Patent defense costs are expensed at the point when it is determined that the outcome is expected to be
unsuccessful. The Company capitalizes the cost of an appeal until it is determined that the appeal will be unsuccessful. The
Company’s capitalized patent defense costs expenses are analyzed for impairment based on the expected eventual outcome of the legal
action and recoverability of proceeds or added economic value of the patent in excess of the costs. Legal actions related to the same
patent defense case are unified into one asset group for the purposes on the impairment analysis. The Company amortizes its other
intangible assets over their estimated useful lives. Patents are amortized over the remaining legal life, up to 20 years. Intangible asset
amortization expense is generally classified as an operating expense. The Company believes that the decision to incur patent costs is
discretionary as the associated products or services can be sold prior to or during the application process. The Company accounts for
other intangible amortization as an operating expense, unless the underlying asset is directly associated with the production or delivery
of a product. To date, the amount of related amortization expense for other intangible assets directly attributable to revenue recognized
is not material. Impairment of patent acquisition costs of $377,000 was recognized in the fourth quarter of 2010 as a result of adverse
decisions in the Company’s patent infringement case against the ECB which caused the Company to reduce the estimated cash flows
that supported the Company’s capitalized patent acquisition based intangible asset.
Conventional Convertible Debt
When the convertible feature of the conventional convertible debt provides for a rate of conversion that is below market value,
this feature is characterized as a beneficial conversion feature (BCF"). Prior to the determination of the BCF, the proceeds from the debt
instrument were first allocated between the convertible debt and any embedded or detachable free standing instruments that are
included, such as common stock warrants. We record a BCF as a debt discount pursuant to FASB ASC Topic 470-20. In those
circumstances, the convertible debt will be recorded net of the discount related to the BCF. We amortize the discount to interest expense
over the life of the debt using the effective interest method.
25
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Revenue Recognition
Sales of security and commercial printing products, packaging and legal products are recognized when a product or service is
delivered, shipped or provided to the customer and all material conditions relating to the sale have been substantially performed.
For digital solutions sales, revenue is recognized in accordance with the FASB ASC 985-605. Accordingly, revenue is
recognized when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the service or
product has been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable (4) the collection
of our fees is reasonably assured.
The Company recognizes revenue from technology licenses once all the following criteria for revenue recognition have been met:
(1) persuasive evidence of an agreement exists; (2) the right and ability to use the product or technology has been rendered; (3) the fee
is fixed and determinable and not subject to refund or adjustment; and (4) collection of the amounts due is reasonably assured.
Business Combinations
The Company adopted the new FASB guidance on business combinations and non-controlling interests. The new guidance on
business combinations retains the underlying concepts of the previously issued standard in that the acquirer of a business is required to
account for the business combination at fair value. As under previous guidance, the assets and liabilities of the acquired business are
recorded at their fair values at the date of acquisition. The excess of the purchase price over the estimated fair values is recorded as
goodwill. The new pronouncement results in some changes to the method of applying the acquisition method of accounting for business
combinations in a number of significant aspects. Under the new guidance, all acquisition costs are expensed as incurred and in-process
research and development costs are recorded at fair value as an indefinite-lived intangible asset. The application of business
combination and impairment accounting requires the use of significant estimates and assumptions.
Share-Based Payments
We measure compensation cost for stock awards at fair value and recognize compensation expense over the service period for
which awards are expected to vest. The Company uses the Black-Scholes option pricing model for determining the estimated fair value
for stock-based awards. The Black-Scholes model requires the use of subjective assumptions which determine the fair value of stock-
based awards, including the option’s expected term and the price volatility of the underlying stock. For equity instruments issued to
consultants and vendors in exchange for goods and services the Company determines the measurement date for the fair value of the
equity instruments issued at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached or
(ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair
value of the equity instrument is recognized over the term of the consulting agreement
The fair value of each option award is estimated on the date of grant utilizing the Black Scholes Option Pricing Model that uses
the assumptions noted in the following table.
Volatility
Expected option term
Risk-free interest rate
Expected forfeiture rate
Expected dividend yield
2010
2009
54.3 % 54.7 %
3.8 years
2.5 %
0.0 %
0.0 %
3.9 years
2.3 %
0.0 %
0.0 %
26
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Income Taxes
Deferred tax assets and liabilities are determined based on temporary differences between income and expenses reported for financial
reporting and tax reporting. FASB ASC 740 requires that a valuation allowance be established when management determines that it is
more likely than not that all or a portion of a deferred tax asset will not be realized. The Company evaluates the realizability of its net
deferred tax assets on an annual basis a valuation allowances are provided or released, as necessary. Since the Company has had
cumulative losses in recent years, the accounting guidance suggest that we should not look to future earnings to support the realizability
of the net deferred tax asset. As a result, as of the years ended December 31, 2010 and 2009, the Company has elected to record a
valuation allowance to reduce net deferred tax assets to zero.
The Company believes that the accounting estimates related to deferred tax valuation allowances are “critical accounting estimates”
because: (1) the need for valuation allowance is highly susceptible to change from period to period due to changes in deferred tax asset
and deferred tax liability balances, (2) the need for valuation allowance is susceptible to actual operating results and (3) changes in the
tax valuation allowance can have a material impact on the tax provisions/benefit in the consolidated statements of operations and on
deferred income taxes in the consolidated balance sheets.
Investment Valuation and Deconsolidation
On October 8, 2009, the Company entered into an Asset Purchase Agreement with Internet Media Services whereby the
Company sold the assets and liabilities of Legalstore, a division of the Company, in exchange for 7,500,000 shares of common stock of
Internet Media Services. The Company recorded its investment in Internet Media Services as an equity method investment at the fair
market value of the business sold. Management determined that the transaction did not qualify as a non-monetary exchange due to the
exception noted in FASB ASC 845-10 ( [ A transfer of assets to an entity in exchange for an equity interest in that entity). Management
determined that the transaction qualified as a derecoginition of a subsidiary under FASB ASC 810-10-40. Therefore, the Company
accounted for the deconsolidation of a subsidiary (“the business”) by recording the consideration received at fair market value and
recognizing a gain in net income measured as the difference between: the fair value of the consideration received (7,500,000 shares of
common stock of Internet Media Services or a 37% interest) and the carrying value of the assets and liabilities sold. Given that the
consideration received is not readily measurable because of the lack of activity in Internet Media Services shares prior to the transaction,
the Company determined that the value of the “business transferred” is more readily measurable by determining the fair market value of
the business transferred based on a discounted cash flow model. The Company is recording the equity method investment at fair
value. Under the equity method investment the Company is required to account for the difference between the cost of an investment and
the amount of the underlying equity in net assets of an investee as if the investee were a consolidated subsidiary. If the investor is
unable to relate the difference to specific accounts of the investee (e.g., property and equipment), the difference should be considered to
be the same as goodwill. Investors should not amortize goodwill associated with equity method investments after the date FASB ASC
350 is initially applied by the entity in its entirety. The Company has determined that given the lack of activity in Internet Media Services
shares prior to the transaction, the difference between the cost of the investment (fair market value) and the underlying equity interest is
attributable to goodwill. The Company is continuing to report the activity in operating loss and not breaking out and reporting it as
discontinued operations because the operations and cash flows of the component have not been eliminated from the ongoing operations
of the entity as a result of the equity method investment and because the Company has significant continuing involvement in the
operations of Internet Media Services after the disposal transaction because of its ownership percentage and board representation.
On September 23, 2010, the Company’s Board of Directors declared a dividend which provided for the distribution by the
Company to its stockholders of record on October 8, 2010,on a pro-rata basis, of its 7,500,000 shares of stock in Internet Media
Services. The dividend was recorded at approximately $229,000 which was the book value of the investment as of September 23, 2010.
Fair Value of Financial Instruments
Effective January 1, 2008, the Company adopted the new accounting guidance relating to fair value measurements as required
by the Fair Value Measurement Topic of the ASC for financial instruments measured at fair value on a recurring basis and effective
January 1, 2009 on a non-recurring basis. The new accounting guidance defines fair value, establishes a framework for measuring fair
value in accordance with U.S. GAAP and expands disclosures about fair value measurements.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. The Fair Value Measurement Topic of the ASC establishes a three-tier fair value
hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in
active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3
measurements). These tiers include:
27
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
·
·
·
Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted
prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active;
and
Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own
assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value
drivers are unobservable.
Derivative instruments are recorded as assets and liabilities at estimated fair value based on available market information. One
of the Company's derivative instruments is an interest rate swap that changes a variable rate into a fixed rate on the term loan and
qualifies as a cash flow hedge and is included in accrued expenses on the accompanying Consolidated Balance Sheet as of December
31, 2010. Gains and losses on these instruments are recorded in other comprehensive income (loss) until the underlying transaction is
recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive income
(loss) (AOCI) to the Consolidated Statement of Operations on the same line item as the underlying transaction. The cumulative net loss
attributable to this cash flow hedge recorded in AOCl at December 31, 2010, was approximately $26,000.
The Company accounts for warrants and other rights to acquire capital stock with exercise price reset features, or “down-round”
provisions, as derivative liabilities. Similarly, anti-dilution provisions for issuances of common stock are also accounted for as derivative
liabilities. These derivative liabilities are measured at fair value with the changes in fair value at the end of each period reflected in
current period income or loss. The fair value of derivative liabilities is estimated using a binomial model or Monte Carlo simulation to
model the financial characteristics, depending on the complexity of the derivative being measured. A Monte Carlo simulation provides a
more accurate valuation than standard option valuation methodologies such as the Black-Scholes or binomial option models when
derivatives include changing exercise prices or different alternatives depending on average future price targets. In computing the fair
value of the derivatives, the Company uses significant judgments, which, if incorrect, could have a significant negative impact to the
Company’s consolidated financial statements. The input values for determining the fair value of the derivatives include observable
market indices such as interest rates, and equity indices as well as unobservable model-specific input values such as certain volatility
parameters.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our audited financial statements for the fiscal years ended December 31, 2010 and 2009 follow Item 15, beginning at page F-1.
28
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ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A - CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial
officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and Rule
15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of December 31, 2010. Based on this evaluation,
our principal executive officer and principal financial officer have concluded that, based on the material weaknesses discussed below, our
disclosure controls and procedures were not effective to ensure that information required to be disclosed by us in reports filed or
submitted under the Securities Exchange Act were recorded, processed, summarized, and reported within the time periods specified in
the Securities and Exchange Act Commission’s rules and forms and that our disclosure controls are not effectively designed to ensure
that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act is accumulated and
communicated to management, including our principal executive officer and principal financial officer, or persons performing similar
functions, as appropriate to allow timely decisions regarding required disclosure.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management’s Annual Report on Internal Control over Financial Reporting
The Company’s management, including the Company’s Chief Executive Officer and Principal Financial Officer assessed the
effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. In making this assessment, our
management used the framework established in “Internal Control—Integrated Framework” promulgated by the Committee of Sponsoring
Organizations of the Treadway Commission, commonly referred to as the “COSO” criteria. Under COSO criteria, a material weakness
exists if there is a control deficiency, or combination of control deficiencies, such that there is a reasonable possibility that a material
misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.
In connection with management’s assessment of our internal control over financial reporting described above, management has
identified the following material weaknesses in the Company’s internal control over financial reporting as of December 31, 2010:
We did not maintain a sufficient complement of qualified accounting personnel and controls associated with segregation of
duties. During 2010 we had one person on staff that performs nearly all aspects of our external financial reporting process, including but
not limited to access to the underlying accounting records and systems, the ability to post and record journal entries and responsibility for
the preparation of the external financial statements. This creates certain incompatible duties and a lack of review over the financial
reporting process that would likely fail to detect errors in spreadsheets, calculations, or assumptions used to compile the financial
statements and related disclosures as filed with the Securities and Exchange Commission (“SEC”). Specifically, we determined that our
controls over the preparation, review and monitoring of the financial statements were ineffective to provide reasonable assurance that
financial disclosures agreed to appropriate supporting detail, calculations or other documentation. In addition, during the preparation of
our annual consolidated financial statements, we determined that certain key assumptions and calculations used in the future cash flow
analysis supporting our asset impairment tests required editing after submission to our auditors. These edits did not result in audit
adjustments to our December 31, 2010 consolidated financial statements. These control deficiencies could result in a material
misstatement to our interim or annual consolidated financial statements that would not be prevented or detected.
Controls associated with identifying and accounting for complex and non-routine transactions in accordance with U.S. generally
accepted accounting principles (“GAAP”) were ineffective. Specifically, during the course of the quarterly interim reviews and the annual
audit, adjustments were made to correct the recorded amounts for the non-monetary dividend and equity based transactions including
the resulting impact on our income tax provision, as well as required disclosures based on the misapplication of GAAP by the Company
that would have resulted in a material misstatement of our financial statements.
As a result of the material weaknesses described above, our management concluded that as of December 31, 2010, we did not
maintain effective internal control over financial reporting based on the criteria established in Internal Control—Integrated Framework
issued by the COSO.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal
control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm
pursuant to Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act that permits us to provide only
management’s report in this annual report.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Plan for Remediation of Material Weaknesses
In response to the identified material weaknesses, management, with oversight from the Company’s audit committee, plans to
review our control environment and to evaluate whether cost effective solutions are available to remedy the identified material
weaknesses by expanding the resources available to the financial reporting process.
Changes in Internal Control over Financial Reporting
There were no changes in our internal controls over the financial reporting during our fourth fiscal quarter that have materially
affected, or are reasonably likely to materially effect, our internal control over financial reporting.
29
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS, CORPORATE GOVERNANCE
PART III
The information required by this Item will be contained in the Company’s Proxy Statement for its 2011 Annual Stockholders
Meeting, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2010, and which is
incorporated by reference herein.
We have adopted codes of business conduct and ethics for all of our employees, including our principal executive officer,
principal financial officer and principal accounting officer. Copies of the codes of business conduct and ethics are available on our Web
site at www.documentsecurity.com.
Our Web site and the information contained therein or incorporated therein are not intended to be incorporated into this Annual
Report on Form 10-K or our other filings with the SEC.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item will be contained in the Company’s Proxy Statement for its 2011 Annual Stockholders
Meeting, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2010, and which is
incorporated by reference herein.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS
The information required by this Item will be contained in the Company’s Proxy Statement for its 2011 Annual Stockholders
Meeting, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2010, and which is
incorporated by reference herein.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item will be contained in the Company’s Proxy Statement for its 2011 Annual Stockholders
Meeting, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2010, and which is
incorporated by reference herein.
ITEM 14 - PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item will be contained in the Company’s Proxy Statement for its 2011 Annual Stockholders
Meeting, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2010, and which is
incorporated by reference herein.
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
PART IV
(a) Exhibits
3.1
3.2
10.1
10.2
10.3
10.4
10.5
10.6
Certificate of Incorporation of Document Security Systems, Inc., as amended*
Amended and Restated By-laws of Document Security Systems, Inc. dated March 18, 2010.*
Form of Registration Rights Agreement dated as of May 29, 2009 between Document Security Systems, Inc. and the
holders listed therein (incorporated by reference to exhibit 10.2 to Form 8-K dated May 29, 2009).
Form of Warrant to Purchase Common Stock of Document Security Systems, Inc. dated May 29, 2009
(incorporated by reference to exhibit 4.1 to Form 8-K dated May 29, 2009).
Form of Subscription Agreement dated as of May 29, 2009 between Document Security Systems, Inc. and the Subscribers
(incorporated by reference to exhibit 10.1 to Form 8-K dated May 29, 2009).
Asset Purchase Agreement between Lester Levin Inc. and Internet Media Services, Inc. dated October 8, 2009
(incorporated by reference to exhibit 2.1 to Form 8-K dated October 8, 2009).
Stock Pledge and Escrow Agreement between Lester Levin Inc., Document Security Systems, Inc., Internet Media
Services, Inc., Michael Buechler and Manufacturers and Traders Trust Company dated October 8, 2009 (incorporated by
reference to exhibit 10.3 to Form 8-K dated October 8, 2009).
Stock Pledge and Escrow Agreement between Lester Levin Inc., Document Security Systems, Inc., Internet Media
Services, Inc., Raymond Meyers and Manufacturers and Traders Trust Company dated October 8, 2009 (incorporated by
reference to exhibit 10.2 to Form 8-K dated October 8, 2009).
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
30
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
10.25
10.26
10.27
10.28
10.29
10.30
10.31
10.32
Voting Agreement between Document Security Systems, Inc., Internet Media Services, Inc., Raymond Meyers and Michael
Buechler dated October 8, 2009 (incorporated by reference to exhibit 10.4 to Form 8-K dated October 8, 2009).
$350,000 Convertible Promissory Note dated November 24, 2009 (incorporated by reference to exhibit 10.1 to Form 8-K
dated December 15, 2009).
$575,000 Promissory Note dated November 24, 2009 (incorporated by reference to exhibit 10.2 to Form 8-K dated
December 15, 2009).
Form of Letter Agreement dated December 11, 2009 (incorporated by reference to exhibit 10.3 to Form 8-K dated
December 15, 2009).
Form of $450,000 Convertible Promissory Note (incorporated by reference to exhibit 10.1 to Form 8-K dated December 30,
2009).
Form of Warrant to Purchase Common Stock of Document Security Systems, Inc. dated January 28, 2010 (incorporated by
reference to exhibit 4.1 to Form 8-K dated February 17, 2010).
Stock Purchase Agreement dated as of February 12, 2010 by and among Robert B. Bzdick and Joan T. Bzdick and
Document Security Systems, Inc. (incorporated by reference to exhibit 10.2 to Form 8-K dated February 17, 2010).
Employment Agreement dated February 12, 2010 between Document Security Systems, Inc. and Robert Bzdick
(incorporated by reference to exhibit 10.3 to Form 8-K dated February 17, 2010).
$1,500,000 Acquisition Term Loan Note dated February 12, 2010 made by Premier Packaging Corporation in favor of RBS
Citizens, N.A. (incorporated by reference to exhibit 10.4 to Form 8-K dated February 17, 2010).
Revolving Line Note dated February 12, 2010 made by Premier Packaging Corporation in favor of RBS Citizens, N.A.
(incorporated by reference to exhibit 10.5 to Form 8-K dated February 17, 2010).
Credit Facility Agreement dated February 12, 2010 by and between Premier Packaging Corporation and RBS Citizens, N.A.
(incorporated by reference to exhibit 10.6 to Form 8-K dated February 17, 2010).
Security Agreement dated February 12, 2010 by and between RBS Citizens, N.A. and Document Security Systems, Inc,
Plastic Printing Professionals, Inc. and Secuprint, Inc. (incorporated by reference to exhibit 10.7 to Form 8-K dated February
17, 2010).
Guaranty and Indemnity Agreement dated February 12, 2010 by and between RBS Citizens, N.A. and Document Security
Systems, Inc., Plastic Printing Professionals, Inc. and Secuprint, Inc. (incorporated by reference to exhibit 10.8 to Form 8-K
dated February 17, 2010).
Form of Subscription Agreement dated as of January 28, 2010 between Document Security Systems, Inc. and Subscribers
(incorporated by reference to exhibit 10.9 to Form 8-K dated February 17, 2010).
Form of Subscription Agreement (incorporated by reference to exhibit 10.1 to Form 8-K/A dated July 21, 2010).
Form of Common Stock Purchase Warrant (incorporated by reference to exhibit 10.2 to form 8-K dated July 21, 2010).
Agreement between Document Security Systems, Inc. and Fletcher International, Ltd. dated December 31, 2010
(incorporated by reference to exhibit 99.1 to Form 8-K dated December 31, 2010).
Warrant Certificate No. 1 dated December 31, 2010 (incorporated by reference to exhibit 99.2 to Form 8-K dated December
31, 2010).
Warrant Certificate No. 2 dated December 31, 2010 (incorporated by reference to exhibit 99.3 to Form 8-K dated December
31, 2010).
Amended and Restated Agreement dated February 18, 2011 (incorporated by reference to exhibit 10.1 to Form 8-K dated
February 24, 2011).
Warrant Certificate No. 3 dated February 18, 2011 (incorporated by reference to exhibit 4.1 to Form 8-K dated February 24,
2011).
Warrant Certificate No. 4 dated February 18, 2011 (incorporated by reference to exhibit 4.2 to Form 8-K dated February 24,
2011).
Amendment dated March 14, 2011 (incorporated by reference to exhibit 10.1 to Form 8-K dated March 17, 2011).
Warrant Certificate No. 5 dated March 14, 2011 (incorporated by reference to exhibit 4.1 to Form 8-K dated March 17,
2011).
Warrant Certificate No. 6 dated March 14, 2011 (incorporated by reference to exhibit 4.2 to Form 8-K dated March 17,
2011).
2004 Employee Stock Option Plan (incorporated by reference to Appendix D to the definitive proxy statement filed with the
SEC on November 17, 2004).
31
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
10.33
10.34
10.35
10.36
10.37
10.38
10.39
10.40
21
23.1
31.1
31.2
32.1
32.2
Non-Executive Director Stock Option Plan (incorporated by reference to Appendix E to the definitive proxy statement filed
with the SEC on November 17, 2004).
Standby Term Loan Note dated October 8, 2010 between Premier Packaging Corporation and RBS Citizens, N.A.
(incorporated by reference to exhibit 10.1 to Form 8-K dated October 12, 2010).
Amended and Restated Credit Facility Agreement dated October 8, 2010 between Premier Packaging Corporation and RBS
Citizens, N.A. (incorporated by reference to exhibit 10.2 to Form 8-K dated October 12, 2010).
Amended and Restated Security Agreement dated October 8, 2010 between RBS Citizens, N.A. and Document Security
Systems, Inc., Plastic Printing Professionals, Inc. and Secuprint, Inc. (incorporated by reference to exhibit 10.3 to Form 8-K
dated October 12, 2010).
Amended and Restated Guaranty and Indemnity Agreement dated October 8, 2010 between RBS Citizens, N.A. and
Document Security Systems, Inc., Plastic Printing Professionals, Inc. and Secuprint, Inc. (incorporated by reference to
exhibit 10.4 to Form 8-K dated October 12, 2010).
Interest Rate Swap Transaction Agreement between Premier Packaging Corporation and RBS Citizens, N.A., dated
February 25, 2010*
Amended and Restated 2004 Employee Stock Option Plan (incorporated by reference to Appendix A to the definitive proxy
statement filed with the SEC on December 8, 2005).
Amended and Restated 2004 Non-Executive Stock Option Plan (incorporated by reference to Appendix B to the definitive
proxy statement filed with the SEC on December 8, 2005).
Subsidiaries of Registrant*
Consent of Freed Maxick & Battaglia, CPAs, PC*
Certification of Chief Executive Officer Pursuant to 18 USC 1350 Section 302*
Certification Principal Accounting Officer Pursuant to 18 USC 1350 Section 302*
Certification of Chief Executive Officer Pursuant to 18 USC 1350 Section 906*
Certification Principal Accounting Officer Pursuant to 18 USC 1350 Section 906*
* filed herewith
32
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements:
Balance Sheets
Statements of Operations
Statements of Cash Flows
Statements of Changes in Stockholders’ Equity
Notes to the Consolidated Financial Statements
Page
F-1
F-2
F-3
F-4
F-5
F6 - F29
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Document Security Systems, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Document Security Systems, Inc. and Subsidiaries as of December
31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then
ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. The Company is not required to have, nor have we been engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures
that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal
control over financial reporting. Accordingly we express no such opinion. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of
Document Security Systems, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the results of its operations and its cash
flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
/s/ FREED MAXICK & BATTAGLIA, CPAs, PC
Buffalo, New York
March 31, 2011
F-1
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
As of December 31,
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable, net of allowance
of $66,000 ($66,000- 2009)
Inventory
Prepaid expenses and other current assets
Total current assets
Equipment and leasehold improvements, net
Other assets
Goodwill
Other intangible assets, net
Investment
Total assets
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable
Accrued expenses and other current liabilities
Revolving line of credit
Current portion of long-term debt
Current portion of capital lease obligations
Total current liabilities
Revolving notes from related party
Long-term debt, net of unamortized discount of $0 in 2010 ($420,000 -2009)
Capital lease obligations
Deferred tax liability
Derivative liabilities
Commitments and contingencies (see Note 13)
Stockholders' equity
Common stock, $.02 par value; 200,000,000 shares authorized,
19,391,319 shares issued and outstanding (16,397,887 in 2009)
Additional paid-in capital
Accumulated other comprehensive loss
Accumulated deficit
Total stockholders' equity
2010
2009
$ 4,086,574 $ 448,895
2,227,877
601,359
231,190
7,147,000
1,143,939
184,174
91,310
1,868,318
2,543,494
325,953
1,943,081
1,847,859
-
$
13,807,387 $
1,286,226
305,507
1,315,721
1,588,969
350,000
6,714,741
$
1,828,138 $
1,312,363
614,833
300,000
88,776
4,144,110
1,673,901
934,595
-
-
78,167
2,686,663
583,000
1,578,242
98,532
89,779
3,866,836
583,000
954,616
182,424
70,830
-
387,825
44,178,569
(25,834)
(41,093,672)
327,957
38,399,033
-
(36,489,782)
3,446,888
2,237,208
Total liabilities and stockholders' equity
$
13,807,387 $
6,714,741
See accompanying notes.
F-2
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended December 31,
Revenue
Security and commercial printing
Packaging
Technology license royalties and digital solutions
Legal products
Total Revenue
Costs of revenue
Security and commercial printing
Packaging
Technology license royalties and digital solutions
Legal products
Total costs of revenue
Gross profit
Operating expenses:
Selling, general and administrative
Research and development
Impairment of intangible assets
Amortization of intangibles
Operating expenses
Operating loss
Other income (expense):
Interest income
Loss on equity investment
Interest expense
Amortizaton of note discount
Gain on deconsolidation of Legalstore.com division
Litigation settlements
Registration rights penalties
Gain on foreign currency transactions
Other income
Loss before income taxes
Income tax expense
Net loss
Other comprehensive loss:
Interest rate swap loss
Comprehensive Loss
Divedend per share
Net loss per share -basic and diluted:
2010
2009
$
6,987,930 $
5,752,601
641,050
-
13,381,581
5,303,952
4,386,829
5,476
-
9,696,257
8,773,131
-
783,453
355,107
9,911,691
6,063,479
-
14,028
178,892
6,256,399
3,685,324
3,655,292
6,136,152
265,360
376,481
803,468
5,733,908
291,538
-
1,342,105
7,581,461
7,367,551
(3,896,137)
(3,712,259)
-
(121,393)
(290,087)
(420,385)
-
-
-
-
143,061
18,140
-
(258,918)
(250,102)
25,755
(115,101)
(109,464)
15,050
415,838
(4,584,941)
(3,971,061)
18,949
18,952
$
(4,603,890) $
(3,990,013)
(25,834)
-
(4,629,724) $
(3,990,013)
0.01 $
-
(0.26) $
(0.27)
$
$
$
Weighted average common shares outstanding, basic and diluted
17,755,141
14,700,453
See accompanying notes.
F-3
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31,
Cash flows from operating activities:
Net loss
Adjustments to reconcile net loss to net cash and cash equivalents used by operating activities:
$ (4,603,890) $ (3,990,013)
2010
2009
Depreciation and amortization
Stock based compensation
Stock based payments for legal settlements
Warrants issuable for registration rights penalty
Amortization of note discount
Gain on deconsolidation of division
Loss on equity investment
Intangible asset impairment
(Increase) decrease in assets:
Accounts receivable
Inventory
Prepaid expenses and other assets
Increase (decrease) in liabilities:
Accounts payable
Accrued expenses and other current liabilities
Net cash used by operating activities
Cash flows from investing activities:
Decrease in restricted cash
Purchase of equipment and leashold improvements
Purchase of other intangible assets
Acquisition of business
Net used by investing activities
Cash flows from financing activities:
Net borrowing on revolving note- related parties
Net borrowings on revolving line of credit
Payments on short-term debt
Borrowings on long-term debt
Payments of long-term debt
Borrowings on long-term convertible notes
Payments of capital lease obligations
Issuance of common stock, net
Net cash provided by financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents beginning of year
1,261,122
423,471
-
-
420,385
-
121,393
376,481
1,661,522
67,709
115,101
109,464
250,102
(25,755)
-
-
200,339
86,977
(101,465)
109,108
73,849
(81,547)
(209,516)
265,450
(1,759,253)
276,070
(160,711)
(1,595,101)
-
(157,422)
(269,729)
(2,000,000)
(2,427,151)
131,004
(62,522)
(176,083)
-
(107,601)
-
342,428
-
1,553,242
(250,000)
-
(73,283)
6,251,696
7,824,083
300,000
-
(900,000)
575,000
-
800,000
(86,124)
1,374,901
2,063,777
3,637,679
448,895
361,075
87,820
Cash and cash equivalents end of year
$ 4,086,574
$
448,895
See accompanying notes.
F-4
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2010 and 2009
Common Stock
Shares
Amount
Additional
Paid-in
Capital
Accumulated
Other
Comprehensive
Income
Subscriptions
Receivable
Accumulated
Deficit
Total
Balance,
December 31,
2008
14,369,764
$
287,395
$ 35,538,695
$
(1,300,000) $
-
$ (32,499,769) $ 2,026,321
Issuance of
common stock, net
Conversion of debt
to equity
Discount on debt
Fair value of
beneficial
conversion features
Stock based
payments, net of
tax effect
Cancellation of
subscribed shares
Net Loss
1,010,000
20,200
1,354,702
1,250,000
-
25,000
-
1,975,000
72,126
-
-
350,871
93,123
1,862
401,139
-
-
-
-
-
(325,000)
(6,500)
(1,293,500)
1,300,000
-
-
-
-
-
-
-
-
-
-
-
-
-
-
(3,990,013)
1,374,902
2,000,000
72,126
350,871
403,001
-
(3,990,013)
Balance,
December 31,
2009
16,397,887
$
327,957
$ 38,399,033 $
-
$
-
$ (36,489,782) $ 2,237,208
Issuance of
common stock, net
Acquisition of
Premier Packaging
Stock based
payments, net of
tax effect
Property dividend
Conversion of debt
Other
comprehensive loss
Derivative liabilities
Net Loss
1,729,129
34,583
5,977,113
735,437
14,709
2,551,966
50,000
1,000
478,866
9,576
555,476
(228,607)
790,424
-
-
-
-
-
-
(3,866,836)
-
-
-
-
-
-
-
-
-
-
-
-
-
(25,834)
-
-
-
-
-
-
-
-
-
(4,603,890)
6,011,696
2,566,675
556,476
(228,607)
800,000
(25,834)
(3,866,836)
(4,603,890)
Balance,
December 31,
2010
19,391,319
$
387,825
$ 44,178,569 $
-
$
(25,834) $ (41,093,672) $ 3,446,888
See accompanying notes.
F-5
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. - DESCRIPTION OF BUSINESS
The Company develops, markets, manufactures and sells paper and plastic products designed to protect valuable information
from unauthorized scanning, copying, and digital imaging. We have developed security technologies that are applied during the normal
printing process and by all printing methods including traditional offset, gravure, flexo, digital or via the internet on paper, plastic, or
packaging. Our technologies and products are used by federal, state and local governments, law enforcement agencies and are also
applied to a broad variety of industries as well, including financial institutions, high technology and consumer goods, entertainment and
gaming, healthcare/pharmaceutical, defense and genuine parts industries. Our customers use our technologies where there is a need for
enhanced security for protection and verification of critical financial instruments and vital records, or where there are concerns of
counterfeiting, fraud, identity theft, brand protection and liability.
NOTE 2. - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - The consolidated financial statements include the accounts of Document Security System and its
subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates - The preparation of consolidated financial statements in conformity with accounting principles generally
accepted in the United States requires us to make estimates and assumptions that affect the amounts reported and disclosed in the
financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we
evaluate our estimates, including those related to the accounts receivable, fair values of intangible assets and goodwill, useful lives of
intangible assets and property and equipment, fair values of options and warrants to purchase our common stock, valuation of derivative
liabilities arising from issuances of common stock and associated warrants and other rights to acquire common stock in the future,
deferred revenue and income taxes, among others. We base our estimates on historical experience and on various other assumptions
that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and
liabilities. We engage third-party valuation consultants to assist management in the allocation of the purchase price of significant
acquisitions and the determination of the fair value of derivative liabilities.
Reclassifications - Certain prior year amounts have been reclassified to conform to the current year presentation.
Cash and Cash Equivalents – The Company maintains its cash in bank deposit accounts and, from time to time, short term
Certificates of Deposits with original maturities of three months or less. For financial statement presentation purposes, the Company
considers those short-term, highly liquid investments with original maturities of three months or less to be cash or cash equivalents.
Accounts Receivable - The Company carries its trade accounts receivable at invoice amount less an allowance for doubtful
accounts. On a periodic basis, the Company evaluates its accounts receivable and establishes an allowance for doubtful accounts
based upon management’s estimates that include a review of the history of past write-offs and collections and an analysis of current
credit conditions. At December 31, 2010, the Company established a reserve for doubtful accounts of approximately $66,000 ($66,000 –
2009). The Company does not accrue interest on past due accounts receivable.
Inventory - Inventories consist primarily of paper, plastic materials and cards, pre-printed security paper, paperboard and fully-
prepared packaging which and are stated at the lower of cost or market on the first-in, first-out (“FIFO”) method. Packaging Work-in-
process and finished goods included the cost of materials, direct labor and overhead.
Equipment and Leasehold Improvements - Equipment and leasehold improvements are recorded at cost. Depreciation is
computed using the straight-line method over the estimated useful lives or lease period of the assets whichever is shorter. Expenditures
for renewals and betterments are capitalized. Expenditures for minor items, repairs and maintenance are charged to operations as
incurred. Any gain or loss upon sale or retirement due to obsolescence is reflected in the operating results in the period the event takes
place. Depreciation expense in 2010 was approximately $458,000 ($319,000- 2009).
F-6
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Investment - On October 8, 2009, the Company entered into an Asset Purchase Agreement with Internet Media Services
whereby the Company sold the assets and liabilities of Legalstore, a division of the Company, in exchange for 7,500,000 shares of
common stock of the Internet Media Services. The Company recorded its investment in Internet Media Services as an equity method
investment at the fair market value of the business sold. Management determined that the transaction qualified as a derecognition of a
subsidiary under FASB ASC 810-10-40. Therefore, the Company accounted for the deconsolidation of a subsidiary (“the business”) by
recording the consideration received at fair market value and recognizing a gain in net income measured as the difference between: the
fair value of the consideration received (7,500,000 shares of common stock of Internet Media Services or a 37% interest) and the
carrying value of the assets and liabilities sold. Given that the consideration received is not readily measurable because of the lack of
activity in Internet Media Services shares prior to the transaction, the Company determined that the value of the “business transferred” is
more readily measurable by determining the fair market value of the business transferred based on a discounted cash flow model. The
Company recorded the equity method investment at fair value. Under the equity method investment the Company is required to account
for the difference between the cost of an investment and the amount of the underlying equity in net assets of an investee as if the
investee were a consolidated subsidiary. If the investor is unable to relate the difference to specific accounts of the investee (e.g.,
property and equipment), the difference should be considered to be the same as goodwill. Investors shall not amortize goodwill
associated with equity method investments after the date FASB ASC 350 is initially applied by the entity in its entirety. The Company
determined that given the lack of activity in Internet Media Services shares prior to the transaction, the difference between the cost of the
investment (fair market value) and the underlying equity interest is attributable to goodwill which difference amounted to approximately
$243,000 at December 31, 2009. For the period from October 9, 2009 through December 31, 2009, the Company’s equity in the
earnings of Internet Media Services was di minimus and not recorded by the Company. The total assets and liabilities of Internet Media
Services as of December 31, 2009 amounted to approximately $350,000 and $60,000, respectively.
The Company recognized gains or losses on its investment under the equity method of accounting for investments. During
2010, the Company recorded a cumulative loss on its investment of approximately $121,000. On September 23, 2010, the Company’s
Board of Directors declared a dividend whereas the Company distributed to its stockholders of record on October 8, 2010 on a pro-rata
basis its 7,500,000 shares of stock of Internet Media Services. As a result, the Company has recorded a dividend of approximately
$229,000 which was the book value of the investment as of September 23, 2010.
Business Combinations -The Company adopted new FASB guidance on business combinations and non-controlling interests.
The new guidance on business combinations retains the underlying concepts of the previously issued standard in that the acquirer of a
business is required to account for the business combination at fair value. As under previous guidance, the assets and liabilities of the
acquired business are recorded at their fair values at the date of acquisition. The excess of the purchase price over the estimated fair
values is recorded as goodwill. The new pronouncement results in some changes to the method of applying the acquisition method of
accounting for business combinations in a number of significant aspects. Under the new guidance, all acquisition costs are expensed as
incurred and in-process research and development costs are recorded at fair value as an indefinite-lived intangible asset. The application
of business combination and impairment accounting requires the use of significant estimates and assumptions.
Goodwill - Goodwill is the excess of cost of an acquired entity over the fair value of amounts assigned to assets acquired and
liabilities assumed in a business combination. Goodwill is not amortized, rather it is tested for impairment annually, and will be tested for
impairment between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be impaired.
Impairment testing for goodwill is done at a reporting unit level. Reporting units are one level below the business segment level, but are
combined when reporting units within the same segment have similar economic characteristics. The Company has three reporting units
based on the current structure. An impairment loss generally would be recognized when the carrying amount of the reporting unit’s net
assets exceeds the estimated fair value of the reporting unit. The Company performs annual assessments and has determined that no
impairment is necessary during the years ended December 31, 2010 and 2009.
Other Intangible Assets, Patent Defense Costs and Patent Application Costs– Other intangible assets consists of costs
associated with the application, acquisition and defense of the Company’s patents, contractual rights to patents and trade secrets
associated with the Company’s technologies and a customer list obtained as a result of acquisitions. The Company’s patents and trade
secrets are for document anti-counterfeiting and anti-scanning technologies and processes that form the basis of the Company’s
document security business. Patent application costs are capitalized and amortized over the estimated useful life of the patent, which
generally approximates its legal life. External legal costs incurred to defend the Company’s patents are capitalized to the extent of an
evident increase in the value of the patents and an expected successful outcome. Patent defense costs are expensed at the point when it
is determined that the outcome is expected to be unsuccessful. The Company capitalizes the cost of an appeal until it is determined that
the appeal will be unsuccessful. The Company’s capitalized patent defense costs expenses are analyzed for impairment based on the
expected eventual outcome of the legal action and recoverability of proceeds or added economic value of the patent in excess of the
costs. Legal actions related to the same patent defense case are unified into one asset group for the purposes on the impairment
analysis. Intangible asset amortization expense is classified as an operating expense. The Company believes that the decision to incur
patent costs is discretionary as the associated products or services can be sold prior to or during the application process. The Company
accounts for other intangible amortization as an operating expense, unless the underlying asset is directly associated with the production
or delivery of a product. Costs incurred to renew or extend the term of recognized intangible assets, including patent annuities and fees,
are expensed as incurred. To date, the amount of related amortization expense for other intangible assets directly attributable to revenue
recognized is not material.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
F-7
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Impairment of Long-Lived Assets - The Company accounts for long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net
undiscounted cash flows expected to be generated by the asset including its ultimate disposition. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value
of the assets. Fair value is determined based on discounted cash flows or appraised values, depending on the nature of the assets.
Fair Value of Financial Instruments - Effective January 1, 2008, the Company adopted the new accounting guidance relating to
fair value measurements as required by the Fair Value Measurement Topic of the FASB ASC for financial instruments measured at fair
value on a recurring basis and effective January 1, 2009 on a non-recurring basis. The new accounting guidance defines fair value,
establishes a framework for measuring fair value in accordance with U.S. GAAP and expands disclosures about fair value
measurements.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. The Fair Value Measurement Topic of the FASB ASC establishes a three-tier fair
value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted
prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3
measurements). These tiers include:
·
·
·
Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted
prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active;
and
Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own
assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value
drivers are unobservable.
The carrying amounts reported in the balance sheet of cash and cash equivalents, accounts receivable, accounts payable and
accrued expenses approximate fair value because of the immediate or short-term maturity of these financial instruments. The fair value
of revolving credit lines, notes payable and long-term debt approximates their carrying value as the stated or discounted rates of the debt
reflect recent market conditions. Derivative instruments are recorded as assets and liabilities at estimated fair value based on available
market information. One of the Company's derivative instruments is an interest rate swap that changes a variable rate into a fixed rate on
the term loan and qualifies as a cash flow hedge and is included in accrued expenses on the accompanying Consolidated Balance Sheet
as of December 31, 2010. Gains and losses on these instruments are recorded in other comprehensive income (loss) until the
underlying transaction is recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other
comprehensive income (loss) (AOCI) to the Consolidated Statement of Operations on the same line item as the underlying
transaction. The cumulative net loss attributable to this cash flow hedge recorded in AOCl at December 31, 2010, was approximately
$26,000.
The Company accounts for warrants and other rights to acquire capital stock with exercise price reset features, or “down-round”
provisions, as derivative liabilities. Similarly, down-round provisions for issuances of common stock are also accounted for as derivative
liabilities. These derivative liabilities are measured at fair value with the changes in fair value at the end of each period reflected in
current period income or loss. The fair value of derivative liabilities is estimated using a binomial model or Monte Carlo simulation to
model the financial characteristics, depending on the complexity of the derivative being measured. A Monte Carlo simulation provides a
more accurate valuation than standard option valuation methodologies such as the Black-Scholes or binomial option models when
derivatives include changing exercise prices or different alternatives depending on average future price targets. In computing the fair
value of the derivatives, the Company uses significant judgments, which, if incorrect, could have a significant negative impact to the
Company’s consolidated financial statements. The input values for determining the fair value of the derivatives include observable
market indices such as interest rates, and equity indices as well as unobservable model-specific input values such as certain volatility
parameters. Future changes in the fair value of the derivatives liabilities, if any, will be recorded in the statement of operations as gains
or losses from derivative liabilities.
F-8
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Conventional Convertible Debt -When the convertible feature of the conventional convertible debt provides for a rate of
conversion that is below market value, this feature is characterized as a beneficial conversion feature (“BCF"). Prior to the determination
of the BCF, the proceeds from the debt instrument were first allocated between the convertible debt and any detachable free standing
instruments that are included, such as common stock warrants. We record a BCF as a debt discount pursuant to FASB ASC Topic 470-
20. In those circumstances, the convertible debt will be recorded net of the discount related to the BCF. We amortize the discount to
interest expense over the life of the debt using the effective interest method. During 2010, the holders of both of the Company’s
convertible notes totaling $800,000 exercised the conversion features of the respective convertible notes for an aggregate of 478,866
shares of the Company’s common stock, which retired the debt in full. In conjunction with the conversions, the Company recognized
approximately $263,000 of unamortized note discount expense.
Share-Based Payments - Compensation cost for stock awards are measured at fair value and recognize compensation expense
over the service period for which awards are expected to vest. The Company uses the Black-Scholes option pricing model for
determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of subjective assumptions which
determine the fair value of stock-based awards, including the option’s expected term and the price volatility of the underlying stock. For
equity instruments issued to consultants and vendors in exchange for goods and services follows the Company determines the
measurement date for the fair value of the equity instruments issued at the earlier of (i) the date at which a commitment for performance
by the consultant or vendor is reached or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity
instruments issued to consultants, the fair value of the equity instrument is recognized over the term of the consulting agreement.
Revenue Recognition - Sales of security and commercial printing products, and legal products are recognized when a product
or service is delivered, shipped or provided to the customer and all material conditions relating to the sale have been substantially
performed.
For digital solutions sales, revenue is recognized in accordance with FASB ASC 985-605. Accordingly, revenue is recognized
when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the service or product has
been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable (4) the collection of our fees is
reasonably assured.
For technology licenses revenue is recognized once all the following criteria for revenue recognition have been met: (1)
persuasive evidence of an agreement exists; (2) the right and ability to use the product or technology has been rendered; (3) the fee is
fixed and determinable and not subject to refund or adjustment; and (4) collection of the amounts due is reasonably assured.
Advertising Costs– Generally consist of online, keyword advertising with Google with additional amounts spent on certain print
media in targeted industry publications. Advertising costs were $32,000 in 2010 ($23,000 – 2009).
Research and Development– Research and development costs are expensed as incurred.
Foreign Currency- Net gains and losses resulting from transactions denominated in foreign currency are recorded as other
income or loss.
Income Taxes - The Company recognizes estimated income taxes payable or refundable on income tax returns for the current
year and for the estimated future tax effect attributable to temporary differences and carry-forwards. Measurement of deferred income
items is based on enacted tax laws including tax rates, with the measurement of deferred income tax assets being reduced by available
tax benefits not expected to be realized. We recognize penalties and accrued interest related to unrecognized tax benefits in income tax
expense.
Earnings Per Common Share - The Company presents basic and diluted earnings per share. Basic earnings per share reflect
the actual weighted average of shares issued and outstanding during the period. Diluted earnings per share are computed including the
number of additional shares that would have been outstanding if dilutive potential shares had been issued. In a loss year, the calculation
for basic and diluted earnings per share is considered to be the same, as the impact of potential common shares is anti-dilutive.
F-9
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
For the years ended December 31, 2010 and 2009, there were up to 2,767,131 and 2,652,886, respectively, of shares potentially
issuable under convertible debt agreements, options, warrants and restricted stock agreements that could potentially dilute basic
earnings per share in the future were excluded from the calculation of diluted earnings per share because their inclusion would have
been anti-dilutive to the Company’s losses in the respective years. This amount includes the warrants issued to Fletcher on December
31, 2010 (as amended on February18, 2011 and March 14, 2011). These amounts do not include potentially issuable shares under
Fletcher’s Later Investment rights which provide Fletcher the right to acquire up to 756,387 shares of the Company’s common stock at a
price per share of $5.38 anytime prior to July 2, 2011. For each share purchased by Fletcher pursuant to the Later Investment, Fletcher
would receive a warrant to purchase an additional share of the Company’s commons stock at $5.38 for up to nine years. If Fletcher
exercises all of its Later Investment Rights, then an additional 756,387 warrants would be issued. (See Note 7).
Concentration of Credit Risk - The Company maintains its cash and cash equivalents in bank deposit accounts, which at times
may exceed federally insured limits. The Company believes it is not exposed to any significant credit risk as a result of any non-
performance by the financial institutions.
During 2010, two customers accounted for 25% and 10% of the Company’s total revenue from continuing operations,
respectively. As of December 31, 2010, these customers accounted for 37% and 7% of the Company’s trade accounts receivable
balance, respectively. During 2009, two customers accounted for 19% and 12% of the Company’s total revenue from continuing
operations, respectively. As of December 31, 2009, two customers’ account receivable balance accounted for 21% and 17% of the
Company’s trade accounts receivable balance, respectively. The risk with respect to trade receivables is mitigated by credit evaluations
we perform on our customers, the short duration of our payment terms for the significant majority of our customer contracts and by the
diversification of our customer base.
Recent Accounting Pronouncements
In January 2010, the FASB issued ASU 2010-6, “Improving Disclosures About Fair Value Measurements” (“ASU 2010-6”), which
requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant
transfers into and out of Level 1 and Level 2 fair-value measurements and information on purchases, sales, issuances, and settlements
on a gross basis in the reconciliation of Level 3 fair- value measurements. ASU 2010-6 is effective for interim and annual reporting
periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for interim and annual
periods beginning after December 15, 2010. The Company partially adopted the requirements within ASU 2010-6 as of January 1, 2010.
The adoption did not have an impact on our financial statements.
In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro
Forma Information for Business Combinations. This ASU specifies that when comparative financial statements are presented, the
revenue and earnings of the combined entity should be disclosed as though the business combination that occurred during the current
year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 is effective for business
combinations with acquisition dates on or after the beginning of the first annual reporting period beginning on or after December 15,
2010; early adoption is permitted. Management is currently evaluating the impact that the adoption of ASU 2010-29 will have and does
not believe the adoption will have a material impact on our consolidated financial statements.
F-10
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
NOTE 3. – INVENTORY
Inventory consisted of the following at December 31,:
Finished Goods
Work in process
Raw Materials
2010
2009
$ 193,346 $ 38,093
58,493
87,588
86,776
321,237
$ 601,359 $ 184,174
NOTE 4. - EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consisted of the following at December 31:
Machinery & equipment
Leasehold improvements
Furniture & fixtures
Software & websites
Total cost
Less accumulated depreciation
2010
2009
Estimated
Useful Life Purchased
Under
Capital
Leases
Purchased
Under
Capital
Leases
5-7 years $
up to 13 years (1)
7 years
3 years
2,514,045
741,919
104,709
356,125
$
$
369,114
-
-
-
$
752,387
735,434
70,209
270,725
547,936
-
-
-
$
3,716,798
1,391,693
$
369,114
150,725
$ 1,828,755
809,082
$
547,936
281,383
Net
$
2,325,105
$
218,389
$ 1,019,673
$
266,553
(1) Expiration of lease term
NOTE 5. - INTANGIBLE ASSETS
Goodwill - The Company performs an annual fair value test of its recorded goodwill for its reporting units using a discounted
cash flow and capitalization of earnings approach. As of December 31, 2010, the Company had goodwill of approximately $1,943,000
($1,316,000- December 31, 2009) attributable to the commercial and security printing segment ($1,316,000) and the packaging segment
($627,000) which was recorded in 2010 as a result of our acquisition of Premier Packaging (See Note 9). In October 2009, we sold the
assets and liabilities associated with Legalstore in exchange for common stock of Internet Media Services. The sale included goodwill
with a net book value of approximately $81,000.
Other Intangible Assets - Other intangible assets are comprised of the following at December 31:
2010
2009
Useful
Life
5 -10 years
Gross
Carrying A
mount
2,038,300
Accumulated
Amortizaton
815,177
Net Carrying
Amount
1,223,123
Gross
Carrying
Amount
Accumulated
Amortizaton
Net Carrying
Amount
666,300
532,285
134,015
Varied
4,729,889
4,729,889
-
4,729,889
3,879,341
850,548
Varied (1)
$
843,693
7,611,882
$
218,957
5,764,023
624,736
$ 1,847,859
776,159
$ 6,172,348
$
171,753
4,583,379
604,406
$ 1,588,969
Acquired intangibles
Patent acquisition
and defense costs
Patent application
costs
(1)- patent rights are amortized over their expected useful life which is generally the legal life of the patent. As of December 31, 2010
the weighted average remaining useful life of these assets in service was 14.8 years.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
F-11
Actual amortization for 2010 and 2009 and expected amortization for each of the next five years is as follows:
2009 Actual
2010 Actual
Expected
$1,342,000
$ 803,000
2011 $ 242,253
232,365
2012
232,365
2013
232,365
2014
147,198
2015
761,313
Thereafter
$1,847,859
Acquired Intangible Assets - In February 2010, the Company acquired intangible assets associated with its acquisition of Premier
Packaging as described in Note 9. These intangible assets were valued at $1,372,000 by an independent valuation firm and
consist of customer lists, amortized over the expected life of 10 years, and a non-compete agreement, amortized over the
expected life of 5 years.
In February 2006, the Company acquired intangible assets associated with its acquisition of the assets of P3. These intangible
assets were valued at $625,300 by an independent valuation firm and consist of customer lists, trade name and brand, and a non-
compete agreement, which will be fully amortized as of February 2011.
Patent Acquisition and Defense Costs- Included in the Company’s capitalized patent defense costs are costs associated with
the acquisition of certain rights associated with patents that the Company is defending. In December 2004, the Company entered into
an agreement with the Wicker Family in which Document Security Systems obtained the legal ownership of technology (including patent
ownership rights) previously held by the Wicker Family. At that time, the agreement with the Wicker Family provided that the Company
would retain 70% of the future economic benefit derived from settlements, licenses or subsequent business arrangements from any
infringer of the Wicker patents that Document Security Systems chooses to pursue. The Wicker Family was to receive the remaining
30% of such economic benefit. In February 2005, the Company further consolidated its ownership of the Wicker Family based patents
and its rights to the economic benefit of infringement settlements when the Company purchased economic interests and legal ownership
from approximately 45 persons and entities that had purchased various rights in Wicker Family technologies over several decades. The
Company issued an aggregate of 541,460 shares of its common stock for the rights of the interest holders and secured 100% ownership
of a US Patent and approximately 16% of additional economic rights to settlements with infringers of the Wicker Family’s foreign
patents. The value of the shares of common stock was determined based upon the closing price of the shares of the Company’s
common stock on the American Stock Exchange on February 15, 2005 of $7.25 per share was, $ 3,905,672 net of expenses. The
Company amortized these costs over the weighted average expected life of the patents underlying the acquired rights, which was 6.75
years as of the date of acquisition. As of December 31, 2010, the net unamortized balance of acquired patent assets was $377,000,
which was recorded in the corporate segment. As a result of the losses in the appeal of two court decisions in the fourth quarter of 2010
related to the Company’s infringement case against the ECB (as described in Note 13- Legal Proceedings), the Company’s management
determined that an impairment of this asset occurred as it is more likely than not that the Company would not receive proceeds from
infringement litigation in these non-European jurisdictions, and the remaining balance was considered impaired.
Patent defense costs are comprised of legal cost associated with our patent infringement suit against the ECB which the
Company commenced in 2005. The Company bases it decision to defer the costs associated with this case on the principal that
successful patent defense costs are capitalizable. First, the Company’s infringement case is based on the relationship of the inventor of
the Company’s patent with various representatives of European currency printers, consultants, and other participants during the late
1990’s in regard to the industry’s attempts to defeat new advanced levels of copier and scanning technologies that were then emerging in
the marketplace. The inventor of the patent had a proven history of success in anti-counterfeiting technology, and was seen as a source
by these industry participants for help solve these challenges. The Company believed that it could establish a direct link between these
communications and the use of the technology by these industry participants in the design and production of the Euro, which was
designed in the late 1990’s and was initially released for circulation in 2002. In addition, prior to filing the ECB litigation, the Company
consulted extensively with legal counsel and performed extensive due diligence with our legal counsel for approximately one year to
analyze the merits of our patent infringement case, and only after these efforts did we take our legal counsel’s recommendation to
proceed with the ECB litigation. Based on the cumulative evidence available to the Company at the time of filing the suit, the Company
believed from the outset of the case that it will be able to prove in court that the ECB infringed the Company’s patent on its Euro notes by
using the Company’s technology in the design of the notes for the specific purpose of making the notes difficult to copy, and therefore the
Company’s infringement case would be successful.
F-12
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
During the course of the ECB litigation, the most significant events in the case were challenges of patent validity by the ECB in
nine jurisdictions in Europe as a core component of its defense. The Company believed that the ECB’s challenge of patent validity
represented the biggest hurdle to a successful outcome of the overall infringement case. During the course of the ECB litigation, the
Company spent approximately $4,247,000 on legal and related court cost associated with defending the patent in these
jurisdictions. The Company amortized these costs over the expected life of the patent which expired as of January 2010. During the
course of the ECB litigation, the Company analyzed the recoverability of its capitalized patent defense costs. The Company used the
potential proceeds from its ECB Litigation as the primary source of future cash flows. Specifically, the Company used assumptions of
banknote production volumes during the alleged infringement period and estimated banknote production costs from third party sources to
determine the estimated total costs of the production of the Euro banknotes in each year of infringement. The Company then applied a
royalty rate that the Company generally charges international licensees and that the Company believes is consistent with industry
standards to determine the amount that would be due to the Company if the ECB had licensed the technology from the Company on the
Company’s standard licensing terms. The Company uses this amount as an estimate of the gross proceeds it could receive from a
successful outcome of the litigation in all jurisdictions. The Company then allocated these potential proceeds by the percent of circulation
of each jurisdiction in which the Company has ongoing litigation to determine the potential proceeds of a successful outcome in the
jurisdictions where the patent has been held as valid or where the patent validity has not yet been determined. Finally, the Company
uses a probability factor in its analysis that discounts these potential future proceeds that takes into account the different status levels of
each jurisdiction. Thus, the Company determined a probability based cash flow which is compared to the net patent defense costs
balance to determine whether an impairment of these costs has occurred. In 2008, as a result of an adverse decision regarding patent
validity in one of the jurisdictions, the United Kingdom, the Company recognized an impairment of approximately $281,000. All other
patent defense costs were amortized over the expected life of the patent and were fully amortized as of January 2010. As of December
31, 2010, there were no longer any unamortized patent defense costs or patent acquisition costs reflected on the Company’s balance
sheet.
In August 2008, the Company entered into an agreement with Trebuchet under which Trebuchet agreed to pay substantially all
of the litigation costs associated with pending validity proceedings and infringement suits, if any, subsequent to that point. Under the
terms of the Agreement, and in consideration for Trebuchet’s funding obligations, the Company assigned and transferred a 49% interest
of the Company’s rights, title and interest in the patent to Trebuchet. Trebuchet will receive 50% of all proceeds from any judgments,
settlements, licenses or other forms of payment received as a result of any litigation. Pursuant to this transaction, the Company
recognized a loss on the sale of patent assets for its assignment and transfer of 49% of its ownership rights in the patent, which had a net
book value of approximately $1,670,000, for proceeds of $500,000.
Patent Application Costs - On an ongoing basis, the Company submits formal and provisional patent applications with the United
States, Canada and countries included in the Patent Cooperation Treaty (PCT). The Company capitalizes these costs and amortizes
them over the patents’ estimated useful life.
NOTE 6. – SHORT TERM AND LONG TERM DEBT
Revolving Note - Related Party- On January 4, 2008, the Company entered into a Credit Facility Agreement with Fagenson and
Co., Inc., as agent, a related party to Robert B. Fagenson, the Chairman of the Company's Board of Directors (the “Fagenson Credit
Agreement” or “Credit Facility”). Under the Fagenson Credit Agreement, the Company could borrow up to a maximum of $3,000,000 from
time to time up to and until January 4, 2010. Any amount borrowed by the Company pursuant to the Fagenson Credit Agreement has
annual interest rate of 2% above LIBOR and is secured by the Common Stock of P3, the Company's wholly owned subsidiary. Interest is
payable quarterly in arrears and the principal is payable in full at the end of the term under the Fagenson Credit Agreement. On
December 11, 2009, the Company entered into a Letter Agreement with the lender for the conversion of $2,000,000 of debt owed under
the Credit Facility into 1,250,000 shares of Document Security Systems common stock. In addition, the parties amended the Credit
Facility to allow for a maximum borrowing of up to $1,000,000 and extended the due date to January 4, 2012. As of December 31, 2010,
the Company had outstanding $583,000 ($583,000 – December 31, 2009) under the Fagenson Credit Agreement. Under the terms of
the Credit Facility the Company is required to comply with various covenants, in which the Company was in violation of one covenant for
the lack of payment of interest. While the Company had not received a notice of default from the lender, the Company did receive a
waiver from the lender for the violation as of December 31, 2010.
F-13
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Interest expense for revolving notes from related parties for the year ended December 31, 2010 was approximately $20,000
($108,000 – 2009) of which approximately $172,000 is included in accrued expenses as of December 31, 2010 ($152,000 –December
31, 2009).
Notes Payable and Revolving Credit Line - On December 9, 2009, the Company used the proceeds from a $350,000
Convertible Note and a $575,000 Promissory Note (collectively, the “Notes”), respectively, to pay in full a $900,000 Term Note. The
$350,000 Convertible Note was set to mature on November 24, 2012, accrued interest at 10% and was convertible into up to 218,750
shares of Document Security Systems common stock. The $575,000 Promissory Note matures on November 24, 2012 accrues interest
at 10%, payable quarterly. Both Notes are secured with equal rights by the assets of the Company’s wholly owned subsidiary, DPI. In
conjunction with the convertible note, the Company determined a beneficial conversion feature existed amounting to approximately
$94,000 which was recorded as discount on debt and was being amortized over the term of the Note. On November 29, 2010, the
holder exercised the conversion feature of the $350,000 Convertible Note for 218,750 shares of Document Security Systems common
stock, par value $0.02 which retired the debt in full. In conjunction with the conversion, the Company recognized approximately $63,000
of note discount expense.
On December 30, 2009, the Company used the proceeds from a $450,000 Convertible Note (“Note”) to pay in full $450,000 due
under a previous Credit Facility due to the Company’s CEO. The $450,000 Note was set to mature on June 23, 2012, accrued interest
at 8%, and was convertible into up to 260,116 shares of Document Security Systems common stock, and was secured by the accounts
receivable of the Company, excluding the accounts receivable of the Company’s wholly owned subsidiaries, P3 and DPI. In conjunction
with the Note, the Company issued to the holders of the Note warrants to purchase up to 65,000 shares of the Company’s common stock
within five years at $2.00 per share. The estimated fair market value of these warrants was determined using the Black Scholes option
pricing model at approximately $72,000, which was recorded as discount on debt and is being amortized over the term of the
Note. Furthermore, in conjunction with this Note, the Company determined a beneficial conversion feature existed amounting to
approximately $257,000, which was recorded as discount on debt and is being amortized over the term of the Note. In addition, the
Company recorded expense of approximately $110,000 for the fair value of 40,000 warrants to purchase the shares of the Company’s
common stock at $2.00 issuable under the terms of the Note as a result of the Company’s failure to timely file a registration statement for
the shares issuable upon conversion of the Note and underlying the warrants, respectively, On December 24, 2010, the holder of the
Note exercised the conversion feature of the Note for 260,116 shares of Document Security Systems common stock, par value $0.02
which retired the debt in full. In conjunction with the conversion, the Company recognized approximately $200,000 of note discount
expense.
On February 12, 2010, the Company acquired all of the outstanding common stock of Premier Packaging. In conjunction with the
transaction, the Company entered into a Credit Facility Agreement with RBS Citizens, N.A. (“Citizens Bank”) pursuant to which Citizens
Bank provided Premier Packaging with a term loan of $1,500,000, and a revolving credit line of up to $1,000,000, which provides for the
ability to get letters of credits based on available revolving credit balances. The Citizens Bank Credit Facility Agreement contains
customary representations and warranties, affirmative and negative covenants, including financial covenants (minimum coverage ratio,
debt to EBITDA ratio, and current ratio requirements) and events of default and is secured by all of the assets of Premier Packaging.
The $1,500,000 term loan matures March 1, 2013 and is payable in 35 monthly payments of $25,000 plus interest commencing March 1,
2010 and a payment of $625,000 on the 36th month. Interest accrues at LIBOR plus 3.75%. The proceeds of the term loan were used
as partial payment of the purchase of all of the outstanding common stock of Premier Packaging. The revolving line of credit up to
$1,000,000 is accessible by the Premier Packaging division subject to certain terms matures on May 13, 2011, as amended, and is
payable in monthly installments of interest only beginning on March 1, 2010. Interest accrues at 1 Month LIBOR plus 3.75%. The
Company subsequently entered into an interest rate swap agreement to lock into a 5.6% effective interest over the life of the term
loan. The amount of the swap liability was $26,000 at December 31, 2010 and is included in accrued expenses in the accompanying
balance sheet. As of December 31, 2010, the remaining principal balance due on the Note was $1,250,000 and there was approximately
$615,000 outstanding on the revolving credit line.
Standby Term Loan Note - On October 8, 2010, the Company amended the Credit Facility Agreement to add a Standby Term
Loan Note pursuant to which Citizens Bank will provide Premier Packaging with up to $450,000 towards the funding of eligible equipment
purchases. The Company has 12 months to draw upon this line of credit, after which the balance of funds advanced from the line is
converted into a 5 year term loan. Interest accrues at LIBOR plus 3.00%. As of December 31, 2010, the Company has drawn
approximately $53,000 from the Standby line for the purchase of equipment.
F-14
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
All of the Citizen’s credit facilities are secured by all of the assets of Premier Packaging and are also secured through cross
guarantees by Document Security Systems and the Company’s other wholly owned subsidiaries, P3 and DPI.
A summary of scheduled principal payments of revolving notes related party and notes payable at December 31, 2010 are as follows:
2011
2012
2013
NOTE 7. - STOCKHOLDERS’ EQUITY
$ 300,000
1,458,000
650,000
$2,408,000
Stock Issued in Private Placements -Between May 29, 2009 and June 22, 2009, the Company sold 56 investment units in a
private placement at a price of $10,000 per unit for aggregate proceeds of $560,000 less $44,000 in expenses, consisting of 400,000
shares of common stock and warrants to purchase an aggregate of 80,000 shares of common stock. The estimated fair market value of
these warrants was determined using the Black Scholes option pricing model at approximately $80,000. On July 15, 2009, the Company
sold 24.5 investment units for $10,000 per unit for gross cash proceeds of $245,000, consisting of 175,000 shares of common stock and
warrants to purchase an aggregate of 35,000 shares of common stock. The estimated fair market value of these warrants was
determined using the Black Scholes option pricing model at approximately $34,000. On August 24, 2009, the Company completed the
sale of 7 investment units in a private placement pursuant to subscription agreements with one accredited investor dated the same
date. In the transaction, the Company sold 7 investment units for $10,000 per unit for gross cash proceeds of $70,000, consisting of
50,000 shares of common stock and warrants to purchase an aggregate of 10,000 shares of common stock. The estimated fair market
value of these warrants was determined using the Black Scholes option pricing model at approximately $10,000. Each investment unit
consisted of 7,142 shares of its common stock and five-year warrants to purchase up to an aggregate of 1,427 shares of its common
stock at an exercise price of $2.00 per share.
On September 4, 2009, the Company completed the sale of 44 investment units in a private placement pursuant to subscription
agreements with three accredited investors dated the same date. Each investment unit is comprised of 6,250 shares of the Company’s
common stock and five year warrants to purchase 1,250 shares of common stock at an exercise price of $2.00 per share. In the
transaction, the Company sold 44 investment units for $10,000 per unit for gross cash proceeds of $440,000, less expenses of $52,000,
consisting of 275,000 shares of common stock and warrants to purchase an aggregate of 55,000 shares of common stock. The estimated
fair market value of these warrants was determined using the Black Scholes option pricing model at approximately $54,000.
On October 19, 2009, the Company completed the sale of 17.6 investment units in a private placement pursuant to subscription
agreements with three accredited investors dated the same date. Each investment unit is comprised of 6,250 shares of the Company’s
common stock and five year warrants to purchase 1,250 shares of common stock at an exercise price of $2.00 per share. In the
transaction, the Company sold 17.6 investment units for $10,000 per unit for gross cash proceeds of $176,000, less expenses of
$17,600, consisting of 110,000 shares of common stock and warrants to purchase an aggregate of 22,000 shares of common stock. The
estimated fair market value of these warrants was determined using the Black Scholes option pricing model at approximately $38,000.
On February 12, 2010, the Company acquired all of the outstanding common stock of Premier Packaging from Robert B. and
Joan T. Bzdick for $2,000,000 in cash and 735,437 shares of the Company's common stock which was valued at $2,566,675.
On February 17, 2010, the Company completed the sale of 20 investment units in a private placement pursuant to subscription
agreements with six accredited investors. Each investment unit was comprised of 5,000 shares of the Company’s common stock and
five year warrants to purchase 1,000 shares of common stock at an exercise price of $3.50 per share. In the transaction, the Company
sold 20 investment units for $15,000 per unit for gross cash proceeds of $300,000, consisting of 100,000 shares of common stock and
warrants to purchase an aggregate of 20,000 shares of common stock. In connection with these sales EKN Financial Services Inc., a
registered broker-dealer, acted as non-exclusive placement agent. EKN Financial Services, Inc. received a cash fee in the aggregate of
$30,000 as commission for these sales. On February 17, 2010, the Company also sold 20 investment units for gross cash proceeds of
$270,000, consisting of an aggregate of 100,000 shares of common stock and warrants to purchase an aggregate of 20,000 shares of
common stock. No placement agent fees were paid on these sales. On February 23, 2010, the Company issued 304,000 shares of
common stock pursuant to the exercise of warrants in which the Company received proceeds of $608,000.
F-15
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
On July 21, 2010 and July 22, 2010, Document Security Systems entered into subscription agreements with twenty two
accredited investors. Under these subscription agreements the Company issued an aggregate of 413,787 shares of common stock and
five-year warrants to purchase up to 82,753 shares of common stock, in consideration of an aggregate of $1,200,000. The warrants are
exercisable at $3.75 per share. The Company paid Aegis Capital Corp., for its services as placement agent, a 7% commission, and a
3% non-accountable expense allowance, in the aggregate amount of $120,000. In addition, we issued the placement agent five year
warrants to purchase 41,379 shares of common stock, exercisable at $3.75 per share.
On February 18, 2011, the Company entered into an Amended and Restated Agreement (“Amended Agreement”) with
Fletcher for the purpose of modifying the terms of an agreement (“Original Agreement”) previously entered into between the Company
and Fletcher on December 31, 2010.
Under the Original Agreement, Fletcher purchased $4,000,000 of the Company’s Common Stock (756,287 shares) at a price of
approximately $5.29 per share on December 31, 2010 (the “Initial Investment”). In conjunction with the Initial Investment, Fletcher
received a warrant (the “Initial Warrant”) to purchase up to $4,000,000 of the Company’s Common Stock at a price of approximately $5.29
per share at any time until December 31, 2019, subject to adjustment as set forth in the Initial Warrant. Under the Original Agreement,
Fletcher also received the right to make additional equity investments of up to $4,000,000 in total (the “Later Investments”) by May 2,
2011 at the average of the daily volume-weighted price of the Company’s Common Stock in the calendar month preceding each Later
Investment notice date at prices no lower than approximately $4.76 per share and no greater than approximately $6.35 per share,
subject to adjustment as set forth in the Original Agreement. The warrants issued to Fletcher have down-round and anti-dilution
provisions as of December 31, 2010, and are considered derivative liabilities recorded at fair value. The down-round provisions result in
the number of shares to be issued determined on a variable that is not an input to the fair value of a “fixed-for-fixed” option. Under the
Original Agreement, Fletcher also received a second warrant (the “Second Warrant”) to purchase shares of the Company’s Common
Stock with an aggregate purchase price of up to the total dollar amount of the Later Investments at a per-share exercise price of 120% of
the per-share price paid in the final Later Investment to occur, subject to adjustment as set forth in the Second Warrant. The Initial
Warrant and the Second Warrant each also have a cashless exercise provision.
Under the Amended Agreement, the purchase price for the Initial Investment made on December 31, 2010 was increased to
$5.38 per share, increasing the aggregate purchase price paid by Fletcher for the Initial Investment from $4,000,000 to $4,068,825. The
Initial Warrant received by Fletcher was amended and reissued (the “Amended Initial Warrant”) entitling Fletcher to purchase newly-
issued shares of Common Stock at $5.38 per share (the “Warrant Price”) at any time until February 18, 2020 (the “Warrant Term”), up to
an aggregate purchase price of $4,300,000 (the “Warrant Amount”). Under the Amended Agreement, Fletcher also received the right to
make additional equity investments (“Later Investments”) of up to $4,068,000 (the “Aggregate Later Investment Amount”) provided notice
is given to the Company prior to July 2, 2011 of Fletcher’s intention to make Later Investments. The Second Warrant received by
Fletcher was amended (the “Amended Second Warrant”, and together with the Amended Initial Warrant, the “Warrants”) to fix the
Warrant Price at $5.38 per share. The Second Warrant entitles Fletcher to purchase newly-issued shares of Common Stock up to the
aggregate purchase price of the Later Investments. The Amended Initial Warrant and the Amended Second Warrant each have a
cashless exercise provision.
In connection with the Amended Agreement, the Company was required to file a registration statement with the SEC covering
the Initial Investment of 756,287 shares and 799,256 shares underlying the Initial Warrant, and to have such registration statement
declared effective no later than April 15, 2011. The Company filed Amendment No. 1 to S-3 Registration Statement with the SEC on
March 7, 2011 in accordance with the requirements of the Amended Agreement. If Fletcher makes any Later Investment purchases of
the Company’s Common Stock, the Company would have similar registration requirements. In the event that any registration statement
is not timely filed or declared effective, or is not kept effective and available in accordance with the Amended Agreement, the Company
will be obligated to pay certain amounts to Fletcher as set forth in the Amended Agreement.
On March 14, 2011, the Company and Fletcher executed further amendments to the Amended and Restated Agreement and
Warrants addressing stockholder approval and pricing provisions relating to Change of Control (as defined therein). The March 14, 2011
amendments were executed by the Company and Fletcher in response to an NYSE Amex inquiry, and were required to solidify NYSE
Amex approval of the Company’s additional listing applications, which approval was received from NYSE Amex on March 15, 2011. The
Company filed Amendment No. 2 to S-3 Registration Statement with the SEC on March 25, 2011.
F-16
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Certain events, such as dividends, stock splits, and other events specified in the Amended Agreement and in the Warrants may
result in additional shares of Common Stock being issued to Fletcher, adjustments being made to the terms of the Later Investments, the
Initial Warrant or the Second Warrant, or other results, in each case as set forth in the Amended Agreement, the Amended Initial Warrant
and the Amended Second Warrant. The terms of the Amended Agreement granted Fletcher certain participation rights in certain later
equity issuances by the Company (except for certain exclusions) and certain other rights upon a change of control, in each case as set
forth in the Amended Agreement, the Amended Initial Warrant and the Amended Second Warrant.
Proceeds from the transaction will be used primarily for sales and marketing, product development, and working capital. The
Company will pay WM Smith & Co., as placement agent, a cash placement fee of 6% of all cash investments received under the
Amended Agreement, or in the case of the cashless exercise of the Warrants, common stock equal to 6% of the shares issued to
Fletcher in conjunction with the cashless exercise. As of December 31, 2010, the Company accrued $240,000 for placement agent fees
paid in January 2011.
Derivative Liabilities
The warrants issued to Fletcher have down-round and anti-dilution provisions as of December 31, 2010, and are considered
derivative liabilities recorded at fair value. The down-round provisions result in the number of shares to be issued determined on a
variable that is not an input to the fair value of a “fixed-for-fixed” option. The Company recognizes the derivative liabilities at their
respective fair values at inception and on each reporting date. The derivative liabilities are considered Level 3 liabilities on the fair value
hierarchy as the determination of fair value includes various assumptions about our future activities and the Company’s stock prices and
historical volatility as inputs. To determine the fair value of the various components of the Fletcher investments, the Company selected
the binomial option model and the Monte Carlo Simulation to model the financial characteristics of the various components. The
derivative liabilities were initially recorded in the consolidated balance sheet upon issuance as of December 31, 2010 at a fair value of
$3,866,836. Future changes in the fair value of the derivatives liabilities, if any, will be recorded in the statement of operations as gains
or losses from derivative liabilities.
The components of the derivative liability, measured at fair value, are summarized as follows at December 31:
Initial Warrant
Later Investment Rights
2010
$3,482,486
384,350
$3,866,836
The table below provides a reconciliation of the beginning and ending balances for the liabilities measured at fair value using significant
unobservable inputs (Level 3). There were no assets as of or during the year ended December 31, 2010 measured using significant
unobservable inputs.
Fair Value Measurements Using Significant Unobservable Inputs (Level 3):
Balance, January 1, 2010
Fair Value upon issuance:
Expensed at issuance
Allocated to net proceeds
Balance, December 31, 2010
Derivative
Liabilities
$
-
-
3,866,836
$3,866,836
F-17
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Stock Warrants - During 2010, in conjunction with the private placements described above, the Company issued an aggregate
of 922,009 warrants to purchase the Company’s shares of common stock at exercise prices ranging from $3.50 to $5.38, as described
above. In addition, in connection with the Fletcher Investment (as described above), the Company issued a contingent warrant for the
purchase of up to the amount of the Later Investment of the Company’s common stock at a price contingent on the purchse price of the
Later Investment, but not less than $5.71 per share. In addition, during 2010, the Company issued to the holders of a Convertible Note
warrants to purchase up to 40,000 shares of the Company’s common stock within five years at $2.00 per share as compensation for a
registration rights penalty.
During 2009, in conjunction with the private placements described above, the Company issued an aggregate of 202,000 warrants
to purchase the Company’s shares of common stock at an exercise price of $2.00, as described above. In addition, during 2009, the
Company issued to the holders of a Convertible Note warrants to purchase up to 65,000 shares of the Company’s common stock within
five years at $2.00 per share. On October 21, 2009, the Company entered into a consulting agreement with Vertical Innovations and
agreed to issue the consultant five year warrants to purchase 50,000 shares of the Company's common stock at $3.00, 100,000 shares of
common stock at $3.50 and 50,000 shares of common stock at $4.00. The Company estimated the value of these warrants at
approximately $258,000 as of December 31, 2009 using the Black-Scholes option pricing model which the Company expects to record
the measurement date fair value as expense over a two year period. On November 19, 2009, the Company entered into an agreement
with Baum Capital for which Baum Capital would execute up to an aggregate amount of $275,000 of Letters of Credit on behalf of the
Company’s subsidiary, DPI, for the extension of credit from certain of DPI’s paper vendors. In exchange, the Company issued to Baum
Capital warrants to purchase 50,000 shares of the Company's common stock at $2.00. The Company valued these warrants at
approximately $56,000 using the Black-Scholes option pricing model which the Company expects to record as expense over a one year
period. On December 7, 2009, the Company reached an agreement to issue 40,000 shares of common stock and 50,000 of common
stock warrants for the purchase of common shares at $3.00 per share for a period of three years from November 23, 2009, in connection
with the settlement of certain litigation between the Company and the recipients. The value of the stock amounted to $85,000 based on
the closing price the day the agreement was reached. The fair value of the warrants of approximately $29,500 was determined utilizing
the Black Scholes pricing model. The aggregate cost of approximately $115,000 is recognized in the statement of operations under
Litigation Settlements. During 2009, the Company recorded expense of approximately $110,000 for the fair value of 40,000 warrants to
purchase the shares of the Company’s common stock at $2.00 issuable to Printer’s LLC as a result of the Company’s failure to file a
registration statement under the terms of the $450,000 Convertible Note the Company entered into in December 2009.
The following is a summary with respect to warrants outstanding and exercisable at December 31, 2010 and 2009 and activity
during the years then ended:
2010
2009
Weighted
Average
Exercise
Price
Warrants
761,032
556,988
-
-
6.15
5.02
(2.16)
(12.59)
$
$
Warrants
1,318,020
962,009
(363,398)
(25,000)
1,891,631
1,891,631
$
$
6.26
6.26
1,318,020
1,118,020
$
$
44.2
F-18
Weighted
Average
Exercise
Price
8.73
2.63
-
-
6.15
6.63
43.0
Outstanding January 1
Granted during the year
Exercised
Lapsed
Outstanding at December 31
Exercisable at December 31
Weighted average months remaining
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Stock Options - The Company has two stock-based compensation plans. The 2004 Employees’ Stock Option Plan (the “2004
Plan”) provides for the issuance of up to a total of 1,700,000 shares of common stock authorized to be issued for grants of options,
restricted stock and other forms of equity to employees and consultants. Under the terms of the 2004 Plan, options granted thereunder
may be designated as options which qualify for incentive stock option treatment (“ISOs”) under Section 422A of the Internal Revenue
Code, or options which do not qualify (“NQSOs”). The exercise price for options granted under the Director Plan is 100% of the fair
market value of the Common Stock on the date of grant. The Non-Executive Director Stock Option Plan (the “Director Plan”) provides for
the issuance of up to a total of 200,000 shares of common stock authorized to be issued for options grants for non-executive directors
and advisors. Under the terms of the Director Plan, an option to purchase (a) 5,000 shares of our common stock shall be granted to each
non-executive director upon joining the Board of Directors and (b) 5,000 shares of our common stock plus an additional 1,000 shares of
our common stock for each year that the applicable director has served on the Board of Directors, up to a maximum of 10,000 shares per
year shall be granted to each non-executive director thereafter on January 2nd of each year; provided that any non-executive director
who has not served as a director for the entire year immediately prior to January 2nd shall receive a pro rata number of options based on
the time the director has served in such capacity during the previous year. Both Plans were adopted by the Company’s shareholders.
The following is a summary with respect to options outstanding at December 31, 2010 and 2009 and activity during the years
then ended:
2004 Employee Plan
Non-Executive Director Plan
Weighted
Average
Exercise
Price
Number of
Options
Weighted
Average Life
Remaining
(in years)
Number of
Options
Weighted
Average
Exercise
Price
Weighted
Average Life
Remaining
(in years)
Outstanding at December 31, 2008
Granted
Exercised
Forfeited
Outstanding at December 31, 2009:
Granted
Exercised
Forfeited
Outstanding at December 31, 2010:
663,500
274,000
-
(298,500)
639,000
185,000
-
(150,500)
673,500
Exercisable at December 31, 2010:
329,850
7.27
4.00
-
(6.37)
6.29
3.40
-
5.54
5.66
7.64
$
115,750
40,000
-
(23,750)
132,000
40,000
-
(15,000)
157,000
117,000
7.99
1.86
-
(4.59)
6.74
2.45
-
(7.14)
5.61
6.69
2.6
1.4
2.4
1.8
Aggregate Intrinsic Value of
outstanding options at December 31,
2010 $
631,225
$
258,800
Aggregate Intrinsic Value of
exercisable options at December 31,
2010 $
116,969
$
141,200
The weighted-average grant date fair value of options granted during the year ended December 31, 2010 was $1.38 ($0.53 -
2009). The aggregate grant date fair value of options that vested during the year was approximately $128,000. There were no options
exercised during the year ended December 31, 2010 or 2009.
The fair value of each option award is estimated on the date of grant utilizing the Black Scholes Option Pricing Model that uses
the assumptions noted in the following table.
F-19
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Volatility
Expected option term
Risk-free interest rate
Expected forfeiture rate
Expected dividend yield
2010
2009
54.3 %
54.7 %
3.8 years
2.5 %
0.0 %
0.0 %
3.9 years
2.3 %
0.0 %
0.0 %
Restricted Stock Issued to Employees – Restricted common stock is issued under the 2004 Plan for services to be rendered
and may not be sold, transferred or pledged for such period as determined by our Compensation Committee. Restricted stock
compensation cost is measured as the stock’s fair value based on the quoted market price at the date of grant. The restricted shares
issued reduce the amount available under the employee stock option plans. Compensation cost is recognized only on restricted shares
that will ultimately vest. The Company estimates the number of shares that will ultimately vest at each grant date based on historical
experience and adjust compensation cost and the carrying amount of unearned compensation based on changes in those estimates over
time. Restricted stock compensation cost is recognized ratably over the requisite service period which approximates the vesting
period. An employee may not sell or otherwise transfer unvested shares and, in the event that employment is terminated prior to the end
of the vesting period, any unvested shares are surrendered to us. We have no obligation to repurchase any restricted stock.
The following is a summary of activity of restricted stock during the years ended at December 31, 2010 and 2009:
Restricted shares outstanding, December 31, 2008
Restricted shares granted
Restricted shares vested
Restricted shares forfeited
Restricted shares outstanding, December 31, 2009
Restricted shares granted
Restricted shares vested
Restricted shares forfeited
Restricted shares outstanding, December 31, 2010
Weighted-average
Grant Date
Fair Value
9.05
-
(6.77)
(10.05)
7.61
-
-
(2.10)
12.50
Shares
327,781
-
$
(30,281)
(212,500)
85,000
$
-
-
(40,000)
$
45,000
As of December 31, 2010, there are 45,000 restricted shares that will vest only upon the occurrence of certain through May 2012
which include, among other things a change of control of the Company or other merger or acquisition of the Company, the achievement
of certain financial goals, including among other things a successful result of the Company’s patent infringement lawsuit against the
European Central Bank. These 45,000 shares, if vested, would result in the recording of stock based compensation expense of
approximately $562,500, the grant date fair value, over the period beginning when any of the contingent vesting events is deemed to be
probable over the expected requisite service period. As of December 31, 2010, vesting is not considered probable and no compensation
expense has been recognized related to the performance grants.
Stock-Based Compensation –Stock-based compensation includes expense charges for all stock-based awards to employees,
directors and consultants. Such awards include option grants, warrant grants, and restricted stock awards. During the year ended
December 31, 2010, the Company had stock compensation expense of approximately $423,000 or $0.02 per share ($292,000- 2009;
$0.02 per share). As of December 31, 2010, there was approximately $368,000 of total unrecognized compensation costs (excluding
the $562,500 that vest upon the occurrence of certain events) related to non-vested options and restricted stock granted under the
Company’s stock option plans which the Company expects to vest over a period of not to exceed five years.
F-20
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
NOTE 8. –DECONSOLIDATION OF LEGALSTORE DIVISION
On October 8, 2009, the Company entered into an Asset Purchase Agreement with Internet Media Services whereby the
Company sold the assets and liabilities of Legalstore, a division of the Company with assets of approximately $252,000 and liabilities of
$13,000, in exchange for 7,500,000 shares of common stock of Internet Media Services. The Company recorded its investment in
Internet Media Services as an equity method investment at the fair market value of the business sold. Management determined that the
transaction did not qualify as a non-monetary exchange due to the exception noted in FASB ASC 845-10 ( [ A transfer of assets to an
entity in exchange for an equity interest in that entity). Management determined that the transaction qualified as a derecoginition of a
subsidiary under FASB ASC 810-10-40. Therefore, the Company accounted for the deconsolidation of a subsidiary (“the business”) by
recording the consideration received at fair market value and recognizing a gain in net income measured as the difference between: the
fair value of the consideration received (7,500,000 shares of common stock of Internet Media Services or a 37% interest) and the
carrying value of the assets and liabilities sold. Given that the consideration received is not readily measurable because of the lack of
activity in Internet Media Services shares prior to the transaction, the Company determined that the value of the “business transferred” is
more readily measurable by determining the fair market value of the business transferred based on a discounted cash flow model
amounted to $350,000, which resulted in a gain of approximately $26,000 which is included in the consolidated statement of operations.
The Company recorded the equity method investment at fair value. Under the equity method investment the Company was required to
account for the difference between the cost of an investment and the amount of the underlying equity in net assets of an investee as if the
investee were a consolidated subsidiary. If the investor is unable to relate the difference to specific accounts of the investee (e.g.,
property and equipment), the difference should be considered to be the same as goodwill. Investors shall not amortize goodwill
associated with equity method investments after the date FASB ASC 350 is initially applied by the entity in its entirety. The Company
determined that given the lack of activity in Internet Media Services shares prior to the transaction, the difference between the cost of the
investment (fair market value) and the underlying equity interest is attributable to goodwill. The Company is continuing to report the
activity in operating loss and not breaking out and reporting it as discontinued operations because the operations and cash flows of the
component have not been eliminated from the ongoing operations of the entity as a result of the equity method investment and because
the Company had significant continuing involvement in the operations of Internet Media Services after the disposal transaction because
of the ownership percentage and board representation. The Company recognized gains or losses on its investment under the equity
method of accounting for investments. During 2010, the Company recorded a cumulative loss in its investment of $121,000. On
September 23, 2010, the Company’s Board of Directors declared a dividend whereas the Company would distribute to its stockholders of
record on October 8, 2010 on a pro-rata basis its shares of stock in Internet Media Services. As a result, the Company has recorded a
dividend of approximately $229,000 which was the book value of the investment as of September 23, 2010.
NOTE 9. –BUSINESS COMBINATIONS
On February 12, 2010, the Company acquired all of the outstanding common stock of Premier Packaging from Robert B. and
Joan T. Bzdick for $2,000,000 in cash and 735,437 shares of the Company's common stock with a value of $2,566,675 at February 12,
2010. In addition, the purchase price was subject to increase if the capital gains tax rate that was in effect as of February 12, 2010 is
retroactively increased by legislation or otherwise whereas the seller’s tax on its gain increases, which did not occur. In addition, the
seller had registration rights for its shares to which the Company was subject to registration penalties of up to $5,000 per month after 120
days, which the sellers waived
The acquisition has been accounted for as a business combination, whereby the Company measured the identifiable assets
acquired and liabilities assumed based on the acquisition date fair value. The Company incurred approximately $30,000 of acquisition
related legal and professional fees that were expensed in the period in which they were incurred. The Company is required to recognize
and measure any related goodwill acquired in the business combination or a gain from a bargain purchase. Management determined
that the fair value of the assets acquired and liabilities assumed was less than the purchase price resulting in the recording of
goodwill. Goodwill totaling approximately $627,000 represents the excess of the purchase price over the fair value of tangible and
identifiable intangible assets acquired, which included $861,000 for customer relationships and $511,000 for non-compete agreement,
and is due primarily to expected increased market penetration from future products in the secure packaging market s and synergies
expected from combining packaging capabilities of Premier Packaging with the printing capabilities of the Company’s DPI division. The
goodwill recorded with the transaction is not deductible for income taxes.
F-21
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
The Company engaged a valuation expert, The Financial Valuation Group, to assist management in determining the fair value of
the assets acquired. The allocation of the purchase price and the estimated useful lives associated with the acquired assets and
liabilities is as follows:
Fair value of the consideration transferred
Fair value of assets acquired and liabilities assumed:
$
4,566,675
Estimated Useful
Lives
Cash
Accounts receivable
Inventories
Machinery and equipment
Other intangible assets
Goodwill
Liabilities assumed:
Accounts payable
Revolving credit lines
Accrued Liabilities
3 to 7 years
5 to 10 years
$
Total Assets $
$
Total Liabilities $
5,290
1,284,227
504,162
1,557,500
1,372,000
627,360
5,350,539
448,128
277,645
58,091
783,864
Total prelimary purchase price
$
4,566,675
Set forth below is the unaudited proforma revenue, operating loss, net loss and loss per share of the Company as if Premier Packaging
had been acquired by the Company as of January 1, 2009.
(unaudited)
Revenue
Operating Loss
Net Loss
Basic and diluted loss per share
Year Ended December 31,
2010
2009
14,265,949
(3,961,963)
(4,671,527)
(0.26)
17,011,427
(3,170,288)
(3,526,173)
(0.24)
Since the acquisition, Premier Packaging had sales of $5,753,000 and profit of $54,000.
NOTE 10. – OTHER INCOME
The Company received $143,000 during 2010 and $416,000 during 2009 for New York State Qualified Emerging Technology
Company (“QETC”) refundable tax credits for the tax years ended 2008, 2007, 2006, and 2005.
F-22
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
NOTE 11. - INCOME TAXES
Following is a summary of the components giving rise to the income tax provision (benefit) for the years ended December 31:
The provision (benefit) for income taxes consists of the following:
Currently payable:
Federal
State
Total currently payable
Deferred:
Federal
State
Total deferred
Less increase in allowance
Net deferred
Total income tax provision (benefit)
Individual components of deferred taxes are as follows:
Deferred tax assets:
Net operating loss carry forwards
Equity issued for services
Other
Total
Less valuation allowance
Gross deferred tax assets
Deferred tax liabilities:
Goodwill
Depreciation and amortization
Gross deferred tax liabilities
Net deferred tax liabilities
2010
2009
$
- $
-
-
-
-
-
(1,150,645)
(274,396)
(1,425,041)
1,443,990
18,949
18,949 $
$
(1,113,695)
(265,310)
(1,379,005)
1,397,957
18,952
18,952
2010
2009
$ 11,909,891 $ 10,330,310
1,006,186
801,204
425,619
138,291
12,849,386
11,762,115
(11,903,718) (11,600,983)
161,132
$
945,668 $
$
$
87,452 $
947,995
1,035,447 $
69,665
162,297
231,962
$
(89,779) $
(70,830)
During 2010, the Company acquired the stock of Premier Packaging. As part of the business combination, various intangible assets and
equipment with fair market values of $1, 372,000 and $1,557,500, respectively, were recorded along with a deferred tax liability of
approximately $1,141,000.
The Company has approximately $32,114,000 in net operating loss carryforwards (“NOL’s”) available to reduce future taxable
income, of which approximately $1,412,000 is subject to change of control limitations that generally restricts the utilization of the NOL per
year and $1,855,000 of the NOL will be allocated to contributed capital when subsequently realized. Due to the uncertainty as to the
Company’s ability to generate sufficient taxable income in the future and utilize the NOL’s before they expire, the Company has recorded
a valuation allowance accordingly. The excess tax benefits associated with stock option exercises are recorded directly to stockholders’
equity only when realized. As a result, the excess tax benefits included in net operating loss carryforwards but not reflected in deferred
tax assets was approximately $1,019,000. .These carryforwards expire at various dates from 2022 through 2030. In addition, a portion
of the valuation allowance amounting to approximately $318,000 will be recorded as a reduction to additional paid in capital in the event
that it is determined that a valuation allowance is no longer considered necessary.
F-23
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
The differences between the United States statutory federal income tax rate and the effective income tax rate in the
accompanying consolidated statements of operations are as follows:
Statutory United States federal rate
State income taxes net of federal benefit
Permanent differences
Change in valuation reserves
2010
2009
34%
4.0
(6.5)
(31.9)
34%
4.4
(3.8)
(35.1)
Effective tax rate
(0.4) %
(0.5) %
At December 31, 2010 and 2009, the total unrecognized tax benefits of $446,000 have been netted against the related deferred tax
assets.
The Company recognizes interest accrued and penalties related to unrecognized tax benefits in tax expense. During the years
ended December 31, 2010 and 2009 the Company recognized no interest and penalties.
The Company files income tax returns in the U.S. federal jurisdiction and various states. The tax years 2007-2010 generally
remain open to examination by major taxing jurisdictions to which the Company is subject.
NOTE 12. - DEFINED CONTRIBUTION PENSION PLAN
The Company has an Employee savings plan (the “401(k) Plan”) which qualifies as a deferred salary arrangement under Section
401(k) of the Internal Revenue Code which covers its employees at its Document Security Systems, P3 and DPI
subsidiaries. Employees become eligible to participate in the Plan at the beginning of the following quarter after the employee’s hire
date. Employees may contribute up to 20% of their pay to the Plan, subject to the limitations of the Internal Revenue Code. Company
matching contributions are discretionary. Pursuant to the 401(k) Plan, employees may elect to defer a portion of their salary on a pre-tax
basis. During the years ended December 31, 2010 and 2009, the Company did not make any matching contributions. In addition, the
Company’s subsidiary, Premier Packaging, which the Company acquired in February 2010, has a 401(k) Plan which allows for employee
salary deferrals with Premier Packaging matching benefits of up to 3% of the employee’s salary. The matching contribution for 2010 was
approximately $25,000.
NOTE 13. – COMMITMENTS AND CONTINGENCIES
Facilities - The Company leases a total of approximately 95,000 square feet of office space for its administrative offices and its
printing facilities at a monthly rental aggregating approximately $49,000. The leases expire at various dates through February 2020,
although renewal options exist to extend lease agreements for up to an additional 60 months. The Company’s lease for its Premier
Packaging facility is with the Company’s COO Bob Bzdick, a related party. The total rent expense for the facility lease with Mr. Bzdick
during the year ended December 31, 2010 amounted to approximately $147,000. Future minimum lease commitments under the facility
lease with Mr. Bzdick subsequent to December 31, 2010 are approximately $160,000 per year for the next five years and $735,000
thereafter.
Equipment Leases - The Company leases digital and offset presses, laminating and finishing equipment for its various printing
operations. The leases may be capital leases or operating leases and are generally for a term of 36 to 60 months. The leases expire
through March 2016.
F-24
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
A summary of lease commitments, including related party lease to Mr. Bzdick, at December 31, 2010 are as follows:
Operating Leases
Capital
Leases
Equipment
Facilities
Total
Payments made in 2010
$
107,052 $
662,701 $
568,115 $
1,230,816
Future minimum lease commitments:
625,218
439,912
296,284
245,100
228,300
54,450
1,889,264 $
627,639
515,540
525,366
313,898
178,333
735,000
2,895,776 $
1,252,857
955,452
821,650
558,998
406,633
789,450
4,785,040
2011
2012
2013
2014
2015
Thereafter
Total future minimum lease commitments
$
Less amount representing interest
Present value of future minimum lease
commitments
Less current portion
107,052
94,453
5,665
-
-
-
207,170 $
(19,862)
187,308
(88,776)
Long term portion
$
98,532
Employment agreements - The Company has employment agreements with four members of its management team with terms
ranging from one to 10 years through February 2020. The agreements provide for severance payments in the event of termination for
certain causes.As of December 31, 2010, the minimum annual severance payments under these employment agreements are, in
aggregate, approximately $1,098,000.
In May 2008, the Company entered into a Separation Agreement with its former President that, among other things, accelerated
the vesting of 33,333 shares of restricted common stock of the Company that were previously awarded to the former President pursuant
to the Company’s 2004 Employee Stock Option Plan so that such shares vested in equal monthly installments during the immediately
following ten months. The Separation Agreement further provided that if the former President did not realize at least $212,000 in gross
proceeds from the sale of such 33,333 shares of restricted stock upon their vesting, then the Company would pay the former President
the amount that such proceeds is less than $212,000 in cash or additional shares of common stock of the Company. As of December
31, 2010, there is no remaining amount due under the agreement. ($74,000 -2009)
Contingent Litigation Payment –In May 2005, the Company made an agreement with its legal counsel in charge of the
Company’s litigation with the European Central Bank which capped the fees for all matters associated with that litigation at $500,000 plus
expenses, and a $150,000 contingent payment upon a successful ruling or settlement on the Company’s behalf in that litigation. The
Company will record the $150,000 in the period in which the Company has determined that a successful ruling or settlement is probable.
In addition, pursuant to an agreement made in December 2004, the Company is required to share the economic benefit derived from
settlements, licenses or subsequent business arrangements that the Company obtains from any infringer of patents formerly owned by
the Wicker Family. For infringement matters involving certain U.S. patents, the Company will be required to disburse 30% of the
settlement proceeds. For infringement matters involving certain foreign patents, the Company will be required to disburse 14% of the
settlement proceeds. These payments do not apply to licenses or royalties to patents that the Company has developed or obtained from
persons other than the Wicker Family. As of December 31, 2010, there have been no settlement amounts related to these agreements.
Legal Proceedings -On August 1, 2005, the Company commenced a suit against the ECB alleging patent infringement by the
ECB and claimed unspecified damages. We brought the suit in the European Court of First Instance in Luxembourg. We alleged that all
Euro banknotes in circulation infringe the Company European Patent 0 455 750B1 (the “Patent”), which covers a method of incorporating
an anti-counterfeiting feature into banknotes or similar security documents to protect against forgeries by digital scanning and copying
devices. The Court of First Instance ruled on September 5, 2007 that it does not have jurisdiction to rule on the patent infringement
claim, and also ruled that we will be required to pay attorneys and court fees of the ECB. The ECB formally requested the Company to
pay attorneys and court fees in the amount of Euro 93,752 which, unless the amount is settled will be subject to an assessment
procedure that has not been initiated, the Company will accrue as soon as the assessed amount, if any, is reasonably estimable.
F-25
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
In 2006, the Company received notices that the ECB had filed separate claims in each of the United Kingdom, The Netherlands,
Belgium, Italy, France, Spain, Germany, Austria and Luxembourg courts seeking the invalidation of the Patent. Proceedings were
commenced before the national courts seeking revocation and declarations of invalidity of the Patent. On March 26, 2007, the High
Court of Justice, Chancery Division, Patents Court in London, England ruled that the Patent was deemed invalid in the United Kingdom,
and on March 19, 2008 this decision was upheld on appeal. As a result of these decisions, the Company was notified of the final
assessment of the reimbursable ECB costs for both court cases was ₤356,490, of which all was paid as of December 31, 2010.
On March 27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled that the German part of the Patent was
valid, having considered the English Court’s decision. On July 6, 2010, the Company was notified that the German Court has ruled that
the Patent, that was awarded to the Company by the European Patent Office and upheld as valid in a previous hearing in the German
Court of First Instance, has now been deemed invalid in Germany due to added matter. On January 9, 2008 the French Court held that
the Patent was invalid in France for the same reasons given by the English Court. The Company filed an appeal against the French
decision on May 7, 2008. On March 20, 2010, the Company was informed that the decision was upheld in the French appeal. On March
12, 2008 the Dutch Court ruled that the Patent is valid in the Netherlands. The ECB filed an appeal against the Dutch decision on
March 27, 2008. The Dutch appeal was heard in June 2010, and the Company was notified on December 21, 2010 that the patent was
deemed invalid upon appeal. On November 3, 2009, the Belgium Court held that the Patent was invalid in Belgium for the same reasons
given by the English and French courts as were similarly informed by the Austrian court on November 17, 2009. Cost reimbursement, if
any, associated with the Belgium, Austrian, and French validity cases as well as the appeals in Germany and France are covered under
the Trebuchet agreement described below. On March 24, 2010 the Spanish Court ruled that the Patent was valid. In Italy the validity
case is to be heard again by a newly appointed judge expected during 2011 and a hearing in Luxembourg thereafter.
On August 20, 2008, the Company entered into an agreement with Trebuchet under which Trebuchet agreed to pay substantially
all of the litigation costs associated validity proceedings in eight European countries relating to the Patent. Trebuchet also agreed to pay
substantially all of the litigation costs associated with any future validity challenges filed by the ECB or other parties, provided that
Trebuchet elects to assume the defense of any such challenges, in its sole discretion, and patent infringement suits filed against the ECB
and certain other alleged infringers of the Patent, all of which suits may be brought at the sole discretion of Trebuchet and may be in the
name of the Company, Trebuchet or both. The Company provided Trebuchet with the sole and exclusive right to manage infringement
litigation relating to the Patent in Europe, including the right to initiate litigation in the name of the Company, Trebuchet or both and to
choose whom and where to sue, subject to certain limitations set forth in the agreement under the terms of the Agreement, and in
consideration for Trebuchet's funding obligations, the Company assigned and transferred a 49% interest of the Company's rights, title
and interest in the Patent to Trebuchet which allows Trebuchet to have a separate and distinct interest in and share of the Patent, along
with the right to sue and recover in litigation, settlement or otherwise to collect royalties or other payments under or on account of the
Patent. In addition, the Company and Trebuchet have agreed to equally share all proceeds generated from litigation relating to the
Patent, including judgments and licenses or other arrangements entered into in settlement of any such litigation. Trebuchet is also
entitled to recoup any litigation expenses specifically awarded to the Company in such actions.
The Patent has thus been confirmed to be valid and enforceable in one jurisdiction (Spain) that uses the Euro as its national
currency allowing the Company or Trebuchet, on the Company’s behalf, to proceed with infringement cases in this country if we choose
to do so. On February 18, 2010, Trebuchet, on behalf of the Company, filed an infringement suit in the Netherlands. The suit was being
lodged against the ECB and two security printing entities with manufacturing operations in the Netherlands, Joh. Enschede Banknotes
B.V.; and Koninklijke Joh. Enschede B.V. and was cancelled upon determination on Dcember 21, 2010, that the patent was invalid in the
Netherlands.
On January 31, 2003, the Company commenced an action, unrelated to the above ECB litigation, entitled New Sky
Communications, Inc., As Successor-In-Interest To Thomas M. Wicker, Thomas M.Wicker Enterprises, Inc. and Document Security
Consultants V. Adler Technologies, Inc. N/K/A Adlertech International, Inc. and Andrew McTaggert (United States District Court, Western
District Of New York Case No.03-Cv-6044t(F)) regarding certain intellectual property in which the Company has an interest. On
December 7, 2009, the Company reached an agreement to terminate all litigation in association with this suit. In conjunction with that
agreement, the Company issued to the opposing parties an aggregate of 40,000 shares of common stock valued at approximately
$85,000 and 50,000 of common stock warrants for the purchase of common shares at $3.00 per share valued at approximately $30,000
utilizing the Black Scholes pricing model. The Company recorded an expense related to the estimated grant date fair value of the shares
and warrants issued of approximately $115,000. In addition, both parties agreed not to compete with certain of the other party’s
customers for 7 years. The Company does not believe that the competition agreement will have a material impact on its business.
F-26
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
In addition to the foregoing, we are subject to other legal proceedings that have arisen in the ordinary course of business and
have not been finally adjudicated. Although there can be no assurance in this regard, in the opinion of management, none of the legal
proceedings to which we are a party, whether discussed herein or otherwise, will have a material adverse effect on our results of
operations, cash flows or our financial condition.
NOTE 14. - SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest
Non-cash investing and financing activities:
2010
2009
$
302,000 $
157,000
Conversion of debt to equity
Equity issued for severance agreements
Non-monetary dividend
Equity issued for acqusition
Equity issued for prepaid services
Accrued placement agent fees
Issuance of derivative liability instruments
Interest rate swap loss
Equipment purchased via capital lease
Warrants issued with debt
Beneficial conversion features of convertible debt
Equity method investment received in exchange for the assets and liabilities of Legalstore.com
800,000
74,000
229,000
2,567,000
115,000
240,000
3,867,000
26,000
-
-
-
-
2,000,000
55,000
-
-
56,000
-
-
-
63,000
72,000
351,000
350,000
NOTE 15. - SEGMENT INFORMATION
The Company's businesses are organized, managed and internally reported as four operating segments. Three of these
operating segments, Document Security Systems, P3 and DPI, are engaged in various aspects of developing and applying printing
technologies and procedures to produce, or allow others to produce, documents with a wide range of features, including the Company’s
patented technologies and trade secrets, along with traditional commercial printing on paper and plastic. For the purposes of providing
segment information, these three operating segments have been aggregated into one reportable segment in accordance with FASB ASC
280. The fourth operating segment is engaged in the production of packaging products and is classified as a separate segment. A
summary of the three segments follows:
Security and
Commercial
Printing
License, manufacture and sale of patented document security technologies, including digital security print
solutions, and general commercial printing, primarily on paper and plastic,comprises the operations of Document
Security Systems, P3 and DPI.
Packaging
The Company acquired Premier Packaging in February 12, 2010 which produces packaging products such as
boxes, mailers, and point of sale displays for various end-users.
Legal Supplies
Sale of specialty legal supplies, primarily to lawyers and law firms located throughout the United States as
Legalstore. During the fourth quarter of 2009, the Company sold its legal products business to Internet Media
Services in exchange for Internet Media Services common stock.
F-27
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Approximate information concerning the Company’s operations by reportable segment as of and for the years ended December
31, 2010 and 2009 is as follows. The Company relies on intersegment cooperation and management does not represent that these
segments, if operated independently, would report the results contained herein:
2010
Supplies
Printing
Division Corporate
Total
Legal
Security and
Commercial
Packaging
Revenues from external customers
Interest Expense and amortization of note discount
Stock based payments
Impairment of patent acquisition costs and other
intangible assets
Depreciation and amortization
Net (loss) profit
Capital Expenditures
Identifiable assets
Revenues from transactions with other operating
segments of the Company.
Other income, net
Loss on equity investment
Income tax expense or benefit.
Stock based compensation
2009
$
- $
-
-
7,629,000 $ 5,753,000 $
78,000
-
34,000
-
- $ 13,382,000
710,000
115,000
598,000
115,000
-
-
-
-
-
-
-
-
-
-
377,000
955,000
(2,633,000)
59,000
4,357,000
-
299,000
54,000
98,000
5,324,000
-
7,000
(2,025,000)
-
377,000
1,261,000
(4,604,000)
157,000
4,126,000 13,807,000
326,000
-
-
-
224,000
110,000
-
-
-
18,000
-
143,000
(121,000)
19,000
181,000
436,000
143,000
(121,000)
19,000
423,000
$
Revenues from external customers
Interest Expense and amortization of note discount
Stock based payments
Depreciation and amortization
Net (loss) profit
Capital Expenditures
Identifiable assets
Other income, net
Income tax expense or benefit.
Stock based compensation
355,000 $
-
-
16,000
40,000
-
-
-
-
-
9,556,000 $
363,000
-
1,644,000
(2,353,000)
302,000
6,276,000
-
-
73,000
- $
-
-
-
-
-
-
-
-
-
146,000
292,000
2,000
(1,400,000)
-
439,000
232,000
19,000
(5,000)
- $ 9,911,000
509,000
292,000
1,662,000
(3,713,000)
302,000
6,715,000
232,000
19,000
68,000
International revenue, which consists of sales to customers with operations in Western Europe, Latin America, Africa, Mddle East
and Asia comprised 2% of total revenue for 2010, (3%- 2009). Revenue is allocated to individual countries by customer based on where
the product is shipped to, location of services performed or the location of equipment that is under an annual maintenance
agreement. The Company had no long-lived assets in any country other than the United States for any period presented.
Major Customers –
During 2010, two customers accounted for 25% and 10% of the Company’s total revenue from continuing operations,
respectively. As of December 31, 2010, these customers accounted for 37% and 7% of the Company’s trade accounts receivable
balance, respectively. During 2009, two customers accounted for 19% and 12% of the Company’s total revenue from continuing
operations, respectively. As of December 31, 2009, two customers’ account receivable balance accounted for 21% and 17% of the
Company’s trade accounts receivable balance, respectively. The risk with respect to trade receivables is mitigated by credit evaluations
we perform on our customers, the short duration of our payment terms for the significant majority of our customer contracts and by the
diversification of our customer base.
F-28
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
NOTE 16. – SUBSEQUENT EVENTS
As discussed in Note 7, on February 18, 2011, and subsequently on March 14, 2011, the Company entered into certain
amendments with Fletcher for the purpose of modifying the terms of an agreement previously entered into between the Company and
Fletcher on December 31, 2010. As a result of the amendments, the down-round and anti-dilution provisions were eliminated, therefore,
the Company determined that the derivative liabilities that existed under the terms of the original agreement no longer exist. As a result,
the Company will revalue these derivative liability instruments as of the modification date with the change in fair value reported in the
statement of operations. The Company will then reclass the derivative liability to equity. Furthermore, the March 14, 2011 amendments
were executed by the Company and Fletcher in response to an NYSE Amex inquiry, and were required to solidify NYSE Amex approval
of the Company’s additional listing applications, which approval was received from NYSE Amex on March 15, 2011.
F-29
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
Report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
March 31, 2011
DOCUMENT SECURITY SYSTEMS, INC.
By: /s/ Patrick White
Patrick White
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed below by the
following persons on behalf of the registrant and in the capacities and on the dates indicated.
March 31, 2011
March 31, 2011
March 31, 2011
March 31, 2011
March 31, 2011
March 31, 2011
March 31, 2011
By: /s/ Robert Fagenson
Robert Fagenson
Director
By: /s/ Patrick White
Patrick White
Chief Executive Officer and Director
(Principal Executive Officer)
By: /s/ David Wicker
David Wicker
Vice President and Director
By: /s/ Timothy Ashman
Timothy Ashman
Director
By: /s/ Alan E. Harrison
Alan E. Harrison
Director
By: /s/ Ira A. Greenstein
Ira A. Greenstein
Director
By: /s/ Philip Jones
Philip Jones
Chief Financial Officer (Principal Financial Officer)
33
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EXHIBIT INDEX
3.1
3.2
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
10.23
10.24
Certificate of Incorporation of Document Security Systems, Inc., as amended*
Amended and Restated By-laws of Document Security Systems, Inc. dated March 18, 2010.*
Form of Registration Rights Agreement dated as of May 29, 2009 between Document Security Systems, Inc. and the
holders listed therein (incorporated by reference to exhibit 10.2 to Form 8-K dated May 29, 2009).
Form of Warrant to Purchase Common Stock of Document Security Systems, Inc. dated May 29, 2009
(incorporated by reference to exhibit 4.1 to Form 8-K dated May 29, 2009).
Form of Subscription Agreement dated as of May 29, 2009 between Document Security Systems, Inc. and the Subscribers
(incorporated by reference to exhibit 10.1 to Form 8-K dated May 29, 2009).
Asset Purchase Agreement between Lester Levin Inc. and Internet Media Services, Inc. dated October 8, 2009
(incorporated by reference to exhibit 2.1 to Form 8-K dated October 8, 2009).
Stock Pledge and Escrow Agreement between Lester Levin Inc., Document Security Systems, Inc., Internet Media
Services, Inc., Michael Buechler and Manufacturers and Traders Trust Company dated October 8, 2009 (incorporated by
reference to exhibit 10.3 to Form 8-K dated October 8, 2009).
Stock Pledge and Escrow Agreement between Lester Levin Inc., Document Security Systems, Inc., Internet Media
Services, Inc., Raymond Meyers and Manufacturers and Traders Trust Company dated October 8, 2009 (incorporated by
reference to exhibit 10.2 to Form 8-K dated October 8, 2009).
Voting Agreement between Document Security Systems, Inc., Internet Media Services, Inc., Raymond Meyers and Michael
Buechler dated October 8, 2009(incorporated by reference to exhibit 10.4 to Form 8-K dated October 8, 2009).
$350,000 Convertible Promissory Note dated November 24, 2009 (incorporated by reference to exhibit 10.1 to Form 8-K
dated December 15, 2009).
$575,000 Promissory Note dated November 24, 2009 (incorporated by reference to exhibit 10.2 to Form 8-K dated
December 15, 2009).
Form of Letter Agreement dated December 11, 2009 (incorporated by reference to exhibit 10.3 to Form 8-K dated
December 15, 2009).
Form of $450,000 Convertible Promissory Note (incorporated by reference to exhibit 10.1 to Form 8-K dated December 30,
2009).
Form of Warrant to Purchase Common Stock of Document Security Systems, Inc. dated January 28, 2010 (incorporated by
reference to exhibit 4.1 to Form 8-K dated February 17, 2010).
Stock Purchase Agreement dated as of February 12, 2010 by and among Robert B. Bzdick and Joan T. Bzdick and
Document Security Systems, Inc. (incorporated by reference to exhibit 10.2 to Form 8-K dated February 17, 2010).
Employment Agreement dated February 12, 2010 between Document Security Systems, Inc. and Robert Bzdick
(incorporated by reference to exhibit 10.3 to Form 8-K dated February 17, 2010).
$1,500,000 Acquisition Term Loan Note dated February 12, 2010 made by Premier Packaging Corporation in favor of RBS
Citizens, N.A. (incorporated by reference to exhibit 10.4 to Form 8-K dated February 17, 2010).
Revolving Line Note dated February 12, 2010 made by Premier Packaging Corporation in favor of RBS Citizens, N.A.
(incorporated by reference to exhibit 10.5 to Form 8-K dated February 17, 2010).
Credit Facility Agreement dated February 12, 2010 by and between Premier Packaging Corporation and RBS Citizens, N.A.
(incorporated by reference to exhibit 10.6 to Form 8-K dated February 17, 2010).
Security Agreement dated February 12, 2010 by and between RBS Citizens, N.A. and Document Security Systems, Inc,
Plastic Printing Professionals, Inc. and Secuprint, Inc. (incorporated by reference to exhibit 10.7 to Form 8-K dated
February 17, 2010).
Guaranty and Indemnity Agreement dated February 12, 2010 by and between RBS Citizens, N.A. and Document Security
Systems, Inc., Plastic Printing Professionals, Inc. and Secuprint, Inc. (incorporated by reference to exhibit 10.8 to Form 8-K
dated February 17, 2010).
Form of Subscription Agreement dated as of January 28, 2010 between Document Security Systems, Inc. and Subscribers
(incorporated by reference to exhibit 10.9 to Form 8-K dated February 17, 2010).
Form of Subscription Agreement (incorporated by reference to exhibit 10.1 to Form 8-K/A dated July 21, 2010).
Form of Common Stock Purchase Warrant (incorporated by reference to exhibit 10.2 to form 8-K dated July 21, 2010).
Agreement between Document Security Systems, Inc. and Fletcher International, Ltd. dated December 31, 2010
(incorporated by reference to exhibit 99.1 to Form 8-K dated December 31, 2010).
Warrant Certificate No. 1 dated December 31, 2010 (incorporated by reference to exhibit 99.2 to Form 8-K dated December
31, 2010).
34
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
10.25
10.26
10.27
10.28
10.29
10.30
10.31
10.32
10.33
10.34
10.35
10.36
10.37
10.38
10.39
10.40
21
23.1
31.1
31.2
32.1
32.2
Warrant Certificate No. 2 dated December 31, 2010 (incorporated by reference to exhibit 99.3 to Form 8-K dated December
31, 2010).
Amended and Restated Agreement dated February 18, 2011 (incorporated by reference to exhibit 10.1 to Form 8-K dated
February 24, 2011).
Warrant Certificate No. 3 dated February 18, 2011 (incorporated by reference to exhibit 4.1 to Form 8-K dated February 24,
2011).
Warrant Certificate No. 4 dated February 18, 2011 (incorporated by reference to exhibit 4.2 to Form 8-K dated February 24,
2011).
Amendment dated March 14, 2011 (incorporated by reference to exhibit 10.1 to Form 8-K dated March 17, 2011).
Warrant Certificate No. 5 dated March 14, 2011 (incorporated by reference to exhibit 4.1 to Form 8-K dated March 17,
2011).
Warrant Certificate No. 6 dated March 14, 2011 (incorporated by reference to exhibit 4.2 to Form 8-K dated March 17,
2011).
2004 Employee Stock Option Plan (incorporated by reference to Appendix D to the definitive proxy statement filed with the
SEC on November 17, 2004).
Non-Executive Director Stock Option Plan (incorporated by reference to Appendix E to the definitive proxy statement filed
with the SEC on November 17, 2004).
Standby Term Loan Note dated October 8, 2010 between Premier Packaging Corporation and RBS Citizens, N.A.
(incorporated by reference to exhibit 10.1 to Form 8-K dated October 12, 2010).
Amended and Restated Credit Facility Agreement dated October 8, 2010 between Premier Packaging Corporation and
RBS Citizens, N.A. (incorporated by reference to exhibit 10.2 to Form 8-K dated October 12, 2010).
Amended and Restated Security Agreement dated October 8, 2010 between RBS Citizens, N.A. and Document Security
Systems, Inc., Plastic Printing Professionals, Inc. and Secuprint, Inc. (incorporated by reference to exhibit 10.3 to Form 8-K
dated October 12, 2010).
Amended and Restated Guaranty and Indemnity Agreement dated October 8, 2010 between RBS Citizens, N.A. and
Document Security Systems, Inc., Plastic Printing Professionals, Inc. and Secuprint, Inc. (incorporated by reference to
exhibit 10.4 to Form 8-K dated October 12, 2010).
Interest Rate Swap Transaction Agreement between Premier Packaging Corporation and RBS Citizens, N.A., dated
February 25, 2010
Amended and Restated 2004 Employee Stock Option Plan (incorporated by reference to Appendix A to the definitive proxy
statement filed with the SEC on December 8, 2005).
Amended and Restated 2004 Non-Executive Stock Option Plan (incorporated by reference to Appendix B to the definitive
proxy statement filed with the SEC on December 8, 2005).
Subsidiaries of Registrant*
Consent of Freed Maxick & Battaglia, CPAs, PC*
Certification of Chief Executive Officer Pursuant to 18 USC 1350 Section 302*
Certification Principal Accounting Officer Pursuant to 18 USC 1350 Section 302*
Certification of Chief Executive Officer Pursuant to 18 USC 1350 Section 906*
Certification Principal Accounting Officer Pursuant to 18 USC 1350 Section 906*
·
filed herewith
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EX-3.1 3 v216851_ex3-1.htm
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EX-3.2 28 v216851_ex3-2.htm
AMENDED AND RESTATED BY-LAWS
OF
DOCUMENT SECURTTY SYSTEMS, INC.
(A New York Corporation)
ARTICLE 1 - PRINCIPAL OFFICE
(1.1) Initial Location. The principal office of the Corporation shall initially be located at
First Federal Plaza, Suite 1525
28 East Main Street
Rochester, New York 14614
(1 .2) Change of Location. The board of directors may, upon reasonable written notice to all shareholders, relocate the principal office of
the Corporation.
(1.3) Other Offices. In addition to its principal office, the Corporation may have such other offices, either within or without the state of
incorporation, as the board of directors may designate.
ARTICLE 2 - DIRECTORS
(2.1) Number. The number of the directors of the Corporation shall be three (3) and no more than seven (7), unless and until otherwise
determined by vote of a majority of the entire Board of Directors. The number of Directors shall not be less than three (3), unless all of the
outstanding shares are owned beneficially and of record by less than three (3) shareholders, in which event the number of directors shall
not be less than the number of shareholders.
(2.2) Election. Except as may otherwise be provided herein or in the Certificate of Incorporation, the members of the Board of Directors
of the Corporation, who need not be shareholders, shall be elected by a majority of the votes cast at a meeting of shareholders, by the
holders of shares entitled to vote in the election.
(2.3) Term of Office. Each director shall hold office until the annual meeting of the shareholders next succeeding his election, and until
his successor is elected and qualified, or until his prior death, resignation or removal.
(2.4) Duties and Powers. The Board of Directors shall be responsible for the control and management of the affairs, property and
interests of the Corporation, and may exercise all powers of the Corporation, except as are in the Certificate of Incorporation or by statute
expressly conferred upon or reserved to the shareholders.
(2.5) Qualification. No person shall serve as a director unless such person is at least 18 years of age.
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(2.6) Notices. Upon taking office, each director shall file with the secretary a written designation of the address That the director desires
to be used for the purpose of giving notices to him/her. Until the director shall have effectively done so, he/she shall be deemed to have
designated either the principal office of the Corporation or any other address that the sender of the notice could reasonably believe to be
an appropriate address. Any designated address may be re-designated by similar filing with the secretary. The secretary shall give each
of the other directors prompt notice of every designation or re-designation filed. The designation or re-designation shall be effective three
business days after the secretary’s action or upon earlier receipt. Any notice to a director shall be valid if sent to either (a) the directors
designated address or b) any other address used in good faith unless it be shown that prejudice resulted from use of such other address.
All notices must be in writing. Any notice may be delivered by hand or sent by telecommunications device, by mail or by similar means. If
a notice is sent by registered mail or return receipt requested, another copy shall at the same time be sent by ordinary first class mail.
(2.7) Resignation. A director may resign at any time by giving notice to each of the other directors. Unless otherwise specified, the notice
shall be effective immediately and acceptance shall not be necessary to make it effective. A director need not assign cause for resigning.
(2.8) Removal. A director may be removed by the shareholders without cause or by the board of directors with cause.
ARTICLE 3 –BOARD OF DIRECTORS
(3.1) Regular Meetings. A regular meeting shall be held immediately after and at the same place as the annual meeting of shareholders.
The board of directors may provide for other regular meetings. Notice need not be given of any regular meeting.
(3.2) Special Meetings. The Chairman or President or any two directors may call a special meeting upon not less than 5 business days
notice to every director of the time and place of the special meeting. The special meeting notice does not have to specify the business to
be transacted.
(3.3) Adjourned Meetings. Whether or not a quorum is present, a majority of the directors present may adjourn any meeting to such
time and place as they shall decide. Notice of any adjourned meeting need not be given at any adjourned meeting, whether adjourned
once or more, any business may be transacted that might have been transacted at the meeting of which it is an adjournment Additional
business may also be transacted if proper notice shall have been given.
(3.4) Chairman. At all meetings of the Board of Directors, the Chairman of the Board, if any and if present, shall preside, If there shall be
no Chairman, or he shall be absent, then the President shall preside, and in his absence, a Chairman chosen by the Directors shall
preside.
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(3.5) Quorum and Adjournments. (a) At all meetings of the Board of Directors, the presence of a majority of the entire Board shall be
necessary and sufficient to constitute a quorum for the transaction of business, except as otherwise provided by law, by the Articles of
Incorporation, or by these By-Laws. Participation of any one or more members of the Board by means of a conference telephone or
similar communications equipment, allowing all persons participating in the meeting to hear each other at the same time, shall constitute
presence in person at any such meeting.
(b) A majority of the directors present at the time and place of any regular or special meeting, although less than a quorum, may adjourn
the same from time to time without notice, until a quorum shall be present.
(3.6) Manner of Acting. (a) At all meetings of the Board of Directors, each director present shall have one vote, irrespective of the
number of shares of stock, if any, which he may hold.
(b) Except as otherwise provided by statute, by the Certificate of Incorporation, or these By-Laws, the action of a majority of the directors
present at any meeting at which a quorum is present shall be the act of the Board of Directors. Any action authorized, in writing, by all of
the directors entitled to vote thereon and filed with the minutes of the Corporation shall be the act of the Board of Directors with the same
force and effect as if the same had been passed by unanimous vote at a duly called meeting of the Board.
(c) Where appropriate communication Facilities are reasonably available, any or all directors shall have the right to participate in any
Board of Directors meeting, or a committee of the Board of Directors meeting, by means of a conference telephone or any means of
communication by which all persons participating in the meeting are able to hear each other.
(3.7) Vacancies. (a) Any vacancy in the Board of Directors occurring by reason of an increase in the number of directors, or by reason of
the death, resignation, disqualification, removal (unless a vacancy created by the removal of a director by the shareholders shall be filled
by the shareholders at the meeting at which the removal was effected) or inability to act of any director, or otherwise, shall be filled for the
unexpired portion of the term by a majority vote of the remaining directors, though less than a quorum, at any regular meeting or special
meeting of the Board of Directors called for that purpose, except whenever the shareholders of any class or classes or series thereof are
entitled to elect one or more Directors by the Certificate of Incorporation of the Corporation, vacancies and newly created directorships of
such class or classes or series may be filled by a majority of the Directors elected by such class or classes or series thereof then in
office, or by a sole remaining Director so elected.
(b) The shareholders, not the Board of Directors, may fill vacancies in the Board of Directors occurring in the Board by reason of removal
of the Directors without cause, unless the Certificate of Incorporation of the Corporation provides that Directors of the Corporation may
also fill such vacancies resulting from removal without cause.
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(c) Unless otherwise provided for by statute, the Certificate of Incorporation or these Bylaws, when one or more Directors shall resign
from the Board and such resignation is effective at a future date, a majority of the Directors, then in office, shall have the power to fill
such vacancy or vacancies, the vote otherwise to take effect when such resignation or resignations shall become effective.
(3.8) Resignation. Any director may resign at any time by giving written notice to the Board of Directors, the President or the Secretary
of the Corporation. Unless otherwise specified in such written notice, such resignation shall take effect upon receipt thereof by the Board
of Directors or such officer, and the acceptance of such resignation shall not be necessary to make it effective.
(3.9) Removal. Any director may be removed with or without cause at any time by the shareholders, at a special meeting of the
shareholders called for that purpose, and may be removed for cause by action of the Board. If a Director was elected by a voting group of
shareholders, only the shareholders of that voting group may participate in the vote to remove that Director.
(3.10) Compensation. The Board of Directors is authorized to make provision for reasonable compensation to its members for their
services as directors and to fix the basis and conditions upon which this compensation shall be paid. Any director may also serve the
Corporation in any other capacity and receive compensation therefor in any form.
(3.1 1) Contracts. (a) No contract or other transaction between this Corporation and any other corporation or entity shall be impaired,
affected or invalidated nor shall any director be liable in any way by reason of the fact that any one or more of the directors of this
Corporation is or are interested in, or is a director or officer, or are directors or officers of such other corporation or other entity, provided
that such material facts are disclosed or made known to the Board of Directors.
(b) Any director, personally and individually, may be a party to or may be interested in any contract or transaction of this Corporation, and
no director shall be liable in any way by reason of such interest, provided that the fact of such interest be disclosed or made known to the
Board of Directors, and provided that the Board of Directors shall authorize, approve or ratify such contract or transaction by the vote (not
counting the vote of any such interested director) of a majority of a quorum, notwithstanding the presence of any such director at the
meeting at which such action is taken. Such director or directors may be counted in determining the presence of a quorum at such
meeting. This Section shall not be construed to impair or invalidate or in any way affect any contract or other transaction which would
otherwise be valid under the law (common, statutory or otherwise) applicable thereto.
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(3.12) Committees. The Board of Directors, by resolution adopted by a majority of the entire Board, may from time to time designate from
among its members an executive, audit, or compensation committee and such other committees, and alternate members thereof, as they
deem desirable, each consisting of two (2) or more directors, with such powers and authority (to the extent permitted by law) as may be
provided in such resolution. Each such committee shall serve at the pleasure of the Board. At all meetings of a committee, the presence
of all members of the committee shall be necessary to constitute a quorum for the transaction of business, except as otherwise provided
by said resolution or by these By-laws. Participation of any one or more members of the committee by means of a conference telephone
or similar communications equipment allowing all persons participating in the meeting to hear each other at the same time, shall
constitute presence in person at any such meeting. Any action authorized in writing by all of the members of a committee entitled to vote
thereon and filed with the minutes of the Committee shall be the act of the committee with the same force and effect as if the same had
been passed by unanimous vote at a duly called meeting of the committee.
(3.13) Telecommunications Participation. Any one or more directors may participate in a meeting of the board or any committee by
means of a conference telephone or other type of telecommunications equipment allowing persons participating in the meeting to hear
each other at the same time.
(3.14) Regulations. The board of directors may adopt rules and regulations, not inconsistent with law, the certificate of incorporation or
these by-laws, for the conduct of its meetings and the management of all aspects of the affairs of the Corporation.
(3.15) Reliance on Books and Records. A member of the Board of Directors or of any committee thereof designated by the Board as
provided in these By-Laws, shall, in the performance of his duties, be fully protected in relying in good faith upon the books of account or
reports made to the Corporation by any of its officers, or by an independent certified public accountant or by an appraiser selected with
reasonable care by the Board of Directors or by any such committee, or in relying in good faith upon other records of the Corporation.
ARTICLE 4 - SHARES AND CERTIFICATES
(4. I) Form of Certificates. Certificates representing shares shall be in the form determined by the board of directors. All certificates
issued shall be consecutively numbered or otherwise appropriately identified.
(4.2) Share Transfer Ledger. There shall be kept a share transfer ledger in which shall be entered full and accurate records including
the names and addresses of all shareholders, the number of shares issued to each shareholder and the dates of issuance. All transfers
of shares shall be promptly reflected in the share transfer ledger. Unless otherwise directed by the board of directors, the share transfer
ledger shall be kept at the principal office of the Corporation and any shareholder of the Corporation is entitled to inspect such list under
the Business Corporation Law of New York.
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(4.3) Transfer of Shares. Upon (a) receipt of the certificate representing the shares to be transferred, either duly endorsed or
accompanied by proper evidence of succession, assignment or authority to transfer, (b) payment of any required transfer taxes, and (c)
payment of any reasonable charge the board of directors may have established, the surrendered certificate shall be canceled and a new
certificate or certificates shall be issued to the person(s) entitled to it.
(4.4) Replacement Certificates. Replacement certificates will be issued at the request of the shareholder upon payment of any
reasonable charge the board of directors may have established. In case of a lost, mislaid, destroyed or mutilated certificate, proof of the
facts, by affidavit or otherwise, may also be required, as may be a bond or other proper indemnification for the Corporation and its
agents.
(4.5) Record Owner to be Treated as Owner. Unless otherwise directed by a court of competent jurisdiction, the Corporation shall treat
the holder of record of any share as the holder in fact and accordingly shall not recognize any equitable or other claim to or interest in the
shares on the part of any other persons, whether or not it shall have express or other notice of it.
ARTICLE 5 – SHAREEOLDERS’ MEETINGS,
(5.1) Annual Meetings. An annual meeting of stockholders shall be held at such time and place as designated by the Board of Directors
within ninety (90) days of the filing of the Company's annual report an Form 10-K, or equivalent, with the Securities and Exchange
Commission; provided, that if the Board of Directors shall determine that in any year it is not advisable or convenient to hold the meeting
within such time period, then in such year the annual meeting shall instead be held on such other day, not more than sixty (60) days
after the expiration of such 90 day period. At each annual meeting, the stockholders shall elect a Board of Directors and transact such
other business as may properly be brought before the meeting.
(5.2) Notice of Meetings. Written notice of each meeting of stockholders, stating the place, date and hour thereof, and, in the case of a
special meeting, specifying the purpose or purposes thereof, shall be given to each stockholder entitled to vote thereat not less than ten
(10) days nor more than sixty (60) days prior to the meeting, except that where the matter to be acted on is a merger or consolidation of
the Corporation or a sale, lease or exchange of all or substantially all of its assets, such notice shall be given not Less than twenty (20)
days nor more than sixty (60) days prior to such meeting. If a meeting is adjourned to another time and place, notice need not be given of
the adjourned meeting if the time and place thereof we announced at the meeting at which the adjournment is taken. If the adjournment
is for more than thirty (30) days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the
adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting.
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(5.3) Special Meetings. A special meeting of the shareholders may be called by any two or more directors, the Chairman or the
President or the holders of no less than 10% of all the shares entitled to vote at the meeting.
(5.4) Adjourned Meetings. Whether or not a quorum is present, a majority in voting power of the shareholders present in person or by
proxy and entitled to vote may adjourn any meeting to a time and place as they shall decide. Notice of any adjourned meeting need not
be given. At any adjourned meeting, whether adjourned once or more, any business may be transacted that might have been transacted
at the meeting of which it is an adjournment. Additional business may also be transacted if proper notice shall have been given.
(5.5) Organization. The Chairman of the Board of Directors shall be the chairman of the meeting. The secretary shall be secretary of the
meeting. If the Chairman is not present, the Chief Executive Officer or President shall preside at the meeting. If none of such persons are
present, then the shareholders shall choose a chairman of the meeting. If neither the secretary nor any assistant secretary is present,
the chairman of the meeting shall appoint a secretary of the meeting.
(5.6) Quorum. (a) Except as otherwise provided herein, or by statute, or in the Certificate of Incorporation (such Certificate and any
amendments thereof being hereinafter collectively referred to as the "Certificate of Incorporation"), at all meetings of shareholders of the
Corporation, the presence at the commencement of such meetings in person or by proxy of shareholders holding of record a majority of
the total number of shares of the Corporation then issued and outstanding and entitled to vote, shall be necessary and sufficient to
constitute a quorum for the transaction of any business. The withdrawal of any shareholder after the commencement of a meeting shall
have no effect on the existence of a quorum, after a quorum has been established at such meeting.
(b) Despite the absence of a quorum at any annual or special meeting of shareholders, the shareholders, by a majority of the votes cast
by the holders of shares entitled to vote thereon, may adjourn the meeting. At any such adjourned meeting at which a quorum is present,
any business may be transacted which might have been transacted at the meeting as originally called if a quorum had been present.
(5.7) Voting. (a) Except as otherwise provided by statute or by the Certificate of Incorporation, any corporate action, other than the
election of directors (which requires the affirmative vote of a plurality of shares entitled to vote) to be taken by vote of the shareholders,
shall be authorized by a majority of votes cast at a meeting of shareholders by the holders of shares entitled to vote thereon.
(b) Except as otherwise provided by statute or by the Certificate of Incorporation, at each meeting of shareholders, each holder of record
of stock of the Corporation entitled to vote thereat, shall be entitled to one vote for each share of stock registered in his name on the
books of the Corporation.
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(c) Each shareholder entitled to vote or to express consent or dissent without a meeting, may do so by proxy; provided, however, that the
instrument authorizing such proxy to act shall have been executed in writing by the shareholder himself, or by his attorney-in-fact
thereunto duly authorized in writing. No proxy shall be valid after the expiration of eleven months from the date of its execution, unless
the persons executing it shall have specified therein the length of time it is to continue in force. Such instrument shall be exhibited to the
Secretary at the meeting and shall be filed with the records of the Corporation.
(d) Any resolution in writing, signed by all of the shareholders entitled to vote thereon, shall be and constitute action by such
shareholders to the effect therein expressed, with the same force and effect as if the same had been duly passed by unanimous vote at a
duly called meeting of shareholders and such resolution so signed shall be inserted in the Minute Book of the Corporation under its
proper date.
(e) There shall be one or more Inspectors at any shareholder's meeting, appointed by the Board of Directors, to act at any such meeting
or any adjournment and make a written report thereof. The Board of Directors may appoint an alternate inspector or inspectors to replace
any inspector who fails to perform his job in a satisfactory way. If no alternate inspector has been appointed and the person or persons
appointed as inspector is unable to act at a shareholders' meeting, the person presiding at the meeting shall appoint one or more
inspectors to act at the meeting.
(f)The date and time of the opening and closing of the polls for each matter upon which the shareholders will vote at a shareholders'
meeting shall be announced by the person presiding at the meeting at the beginning of the meeting and, if no such opening and closing
date and time is announced, the polls shall close at the end of the meeting, including any adjournment thereof. No ballots, proxies or
consents, not any revocation thereof or changes thereto shall be accepted by the inspectors after the closing of the polls unless the New
York Supreme Court at a special term held within the judicial district where the Corporation's office is located upon application by a
shareholder of the Corporation, shall determine otherwise.
(5.8) Business Before a Meeting. To be properly brought before the meeting, business must be either (a) specified in the notice of
meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (b) otherwise properly brought before the
meeting by or at the direction of the Board, or (c) otherwise properly brought before the meeting by a stockholder. In addition to any other
applicable requirements, for business to be properly brought before an annual meeting by a stockholder, the stockholder must have
given timely notice thereof in writing, either by personal delivery or by United States mail, postage prepaid, to the Secretary of the
Company not later than 90 days prior to the meeting anniversary date of the immediately preceding annual meeting or if no annual
meeting was held for any reason in the preceding year, 90 days prior to the first Wednesday in December. A stockholder's notice to the
Secretary shall set forth as to each matter the stockholder proposes to bring before the meeting (i) a brief description of the business
desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and
record address of the stockholder proposing such business, (iii) the class and number of shares of the Company which are beneficially
owned by the stockholder and (iv) any material interest of the stockholder in such business.
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Notwithstanding anything in the By-Laws to the contrary, no business shall be conducted at the annual meeting except in accordance
with the procedures set forth in this Section 5.8 of Article 5, provided, however, that nothing in this Section 5.8 of Article 5 shall be
deemed to preclude discussion by any stockholder of any business properly brought before the annual meeting,
The Chairman of an annual meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly
brought before the meeting in accordance with the provisions of this Section 5.8 of Article 5 and if he should so determine, which
determination shall be conclusive, he shall so declare to the meeting and any such business not properly brought before the meeting
shall not be transacted.
(5.9) Stockholder List. The Secretary of the Corporation shall prepare and make, or cause to be prepared and made, at least ten (10)
days before every meeting of stockholders, a complete list of the stockholders, arranged in alphabetical order, and showing the address
of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of
any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to
the meeting, either at a place within the city or other municipality or community where the meeting is to be held, which place shall be
specified in the notice of the meeting, or if not so specified, at the place where the meeting is to be held. The list shall also be produced
and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present.
The stock ledger shall be the only evidence as to who are the stockholders entitled to examine the stock ledger, the list required by this
subsection or the books of the Corporation, or to vote in person or by proxy at any meeting of stockholders.
ARTICLE 6 - OFFICERS
(6.1) Number. Qualifications. Election and Term of Office. (a) The officers of the Corporation shall consist of a Chief Executive
Officer, President, a Secretary, a Chief Financial Officer or a Treasurer, and such other officers, including, but not limited to, a Chairman
of the Board of Directors, and one or more Vice Presidents, as the Board of Directors may from time to time deem advisable. Any officer
other than the Chairman of the Board of Directors may be, but is not required to be, a director of the Corporation. Any two or more offices
may be held by the same person.
(b) The officers of the Corporation shall be elected by the Board of Directors at the regular annual meeting of the Board following the
annual meeting of shareholders.
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(c) Each officer shall hold office until the annual meeting of the Board of Directors next succeeding his election, and until his successor
shall have been elected and qualified, or until his death, resignation or removal.
(6.2) Resignation. Any officer may resign at any time by giving written notice of such resignation to the Board of Directors, or to the
President or the Secretary of the Corporation. Unless otherwise specified in such written notice, such resignation shall take effect upon
receipt thereof by the Board of Directors or by such officer, and the acceptance of such resignation shall not be necessary to make it
effective.
(6.3) Removal. Any officer may be removed, either with or without cause, and a successor elected by the
Board at any time.
(6.4) Vacancies. A vacancy in any office by reason of death, resignation, inability to act, disqualification, or any other cause, may at any
time be filled for the unexpired portion of the term by the Board of Directors.
(6.5) Additional Officers. In addition to the Chief Executive Officer, President, Secretary, Chief Financial Officer, Treasurer and any
other officers required by law, the Corporation may have one or more vice presidents elected by the board of directors, one of whom may
be designated as executive vice president. The Corporation may also have such other or assistant officers as may be elected by, or
appointed in a manner prescribed by, the board of directors.
(6.6) Continuation in Office. Unless otherwise provided by the board of directors, every officer shall serve until death, incapacity,
resignation or removal by the board of directors. Any resignation or removal shall be without prejudice to any contractual rights of the
Corporation or the officer.
(6.7) Duties in General. Subject to these by-laws, the authority and duties of all officers shall be determined by, or in the manner
prescribed by, the board of directors. Except as may be specifically restricted by the board of directors, any officer may delegate any of
his/her authority and duties to any subordinate officer
(6.8) Duties of the President. The President shall, in the absence of a Chief Executive Officer, be the principal executive officer of the
Corporation and, subject to the control of the board of directors, shall in general supervise and control all of the business and affairs of
the Corporation. The president may sign, with the secretary or any other proper officer of the Corporation thereunto authorized by the
board of directors, certificates for shares of the Corporation, any deeds, mortgages, bonds, contracts, or other instruments that the board
of directors has authorized to be executed, except in cases where the signing and execution shall be expressly delegated by the board of
directors or by these by-laws to some other officer or agent of the Corporation or shall be required by law to be otherwise signed or
executed, and in general shall perform all duties incident to the office of president and such other duties as may be prescribed by the
board of directors from time to time.
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(6.9)Duties of Vice Presidents. In the absence or incapacity of the president, the senior vice president shall perform the duties of the
president and, when so acting, shall have all the powers of and be subject to all the restrictions upon the president. Each vice president
shall perform any other duties as may be assigned by the president or by the board of directors.
(6.10) Duties of Secretary. The secretary shall keep the minutes of the shareholders and the directors' meetings in one or more books
provided for that purpose, see that all notices are duly given in accordance with the provisions of these by-laws or as otherwise required,
be custodian of the corporate records and of the seal of the Corporation, keep a register of the post office addresses of each shareholder,
have general charge of the share transfer books of the Corporation, and in general perform all duties incident to the office of secretary
and other duties as may be assigned by the president or by the board of directors.
(6.11) Duties of Treasurer. If required by the board of directors, the treasurer shall give a bond for the faithful discharge of his/her duties
in a sum and with any surety or sureties as the board of directors shall determine. The treasurer shall have charge and custody of and be
responsible for all finds and securities of the Corporation, receive and give receipts for monies due and payable to the Corporation from
any source whatsoever, and deposit all such monies in the name of the Corporation in the banks, trust companies or other depositories
as shall be selected in accordance with these by-laws, and in general perform all the duties incident to the office of treasurer and such
other duties as may be assigned by the president or the board of directors.
(6.12) Shares of Other Corporations. Whenever the Corporation is the holder of shares of any other corporation, any right or power of the
Corporation as such shareholder (including the attendance, acting and voting at shareholders' meetings and execution of waivers,
consents, proxies or other instruments) may be exercised on behalf of the Corporation by the Chief Executive Officer President, any Vice
President, or such other person as the Board of Directors may authorize.
(7.1) Dividends. Subject to applicable law and the Certificate of Incorporation, dividends may be declared and paid out of any funds
available therefor, as often, in such amounts, and at such time or times as the Board of Directors may determine, provided, however, that
the Corporation is not insolvent when such dividend is paid or rendered insolvent by the payment of such dividend.
ARTICLE 7 - DIVIDENDS
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ARTICLE 8 - FISCAL YEAR
(8.1). FiscalYear. The fiscal year of the Corporation shall be fixed by the Board of Directors from time to time, subject to applicable law.
ARTICLE 9 - CORPORATE SEAL
(9.1) Corporate Seal. The corporate seal, if any, shall be in such form as shall be approved from time to time by the Board of Directors.
ARTICLE 10 – INDEMNIFICATION OF DIRECTORS AND OFFICERS
(10.1) Indemnification of Directors and Officers. Except to the extent expressly prohibited by the Business Corporation Law of New
York, the Corporation shall indemnify each person made or threatened to be made a party to any action or proceeding, whether civil or
criminal, by reason of the fact that such person or such person's testator or intestate is or was a director, officer or employee of the
Corporation, or serves or served at the request of the Corporation, any other Corporation, partnership, joint venture, trust, employee
benefit plan or other enterprise in any capacity, against judgment, fines, ,penalties, amounts paid in settlement and reasonable
expenses, including attorneys' fees, incurred in connection with such action or proceeding, or any appeal therein, provided that no such
indemnification shall be made if a judgment or other final adjudication adverse to such person establishes that his or her acts were
committed in bad faith or were the result of active and deliberate dishonesty and were material to the cause of action so adjudicated, or
that he or she personally gained in fact a financial profit or other advantage to which he or she was not legally entitled, and provided
further that no such indemnification shall be required with respect to any settlement or other nonadjudicated disposition of any
threatened or pending action or proceeding unless the Corporation has given its prior consent to such settlement or other disposition.
The Corporation may advance or promptly reimburse upon request any person entitled to indemnification hereunder for all expenses,
including attorneys' fees, reasonably incurred in defending any action or proceeding in advance of the final disposition thereof upon
receipt of an undertaking by or on behalf of such person to repay such amount if such person is ultimately found not to be entitled to
indemnification or, where indemnification is granted, to the extent the expenses so advanced or reimbursed exceed the amount to which
such person is entitled, provided, however, that such person shall cooperate in good faith with any request by the Corporation that
common counsel be utilized by the parties to an action or proceeding who are similarly situated unless to do so would be inappropriate
due to actual or potential differing interests between or among such parties.
Nothing herein shall limit or affect any right of any person otherwise than hereunder to indemnification or expenses, including attorneys'
fees, under any statute, rule, regulation, certificate of incorporation, by-law, insurance policy, contract or otherwise.
Anything in these by-laws to the contrary notwithstanding, no elimination of this bylaw, and no amendment of this bylaw adversely
affecting the right of any person to indemnification or advancement of expenses hereunder shall be effective until the 60th day following
notice to such person or such action, and no elimination of or amendment to this by law shall deprive any person of his or her rights
hereunder arising out of alleged or actual occurrences, acts or failures to act prior to such 60thday. The Corporation shall not, except by
elimination or amendment of this by law in a manner consistent with the preceding paragraph, take any corporate action or enter into any
agreement which prohibits, or otherwise limits the rights of any person to, indemnification in accordance with the provisions of this by-
law. The indemnification of any person provided by this bylaw shall continue after such person has ceased to be a director, officer or
employee of the Corporation and shall inure to the benefit of such person's heirs, executors, administrators and legal representatives.
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The Corporation is authorized to enter into agreements with any of its directors, officers or employees extending rights to indemnification
and advancement of expenses to such person to the Fullest extent permitted by applicable law, but the failure to enter into any such
agreement shall not affect or limit the rights of such person pursuant to this bylaw, it being expressly recognized hereby that all directors,
officers and employees of the Corporation, by serving as such after the adoption hereof, are acting in reliance hereon and that the
Corporation is stopped to contend otherwise.
In case any provision in this by-law shall be determined at any time to be unenforceable in any respect, the other provisions shall not in
any way be affected or impaired thereby, and the affected provision shall be given the fullest possible enforcement in the circumstances,
it being the intention of the Corporation to afford indemnification and advancement of expenses to its directors, officers and employees,
acting in such capacities or in the other capacities mentioned herein, to the fullest extent permitted by law.
For purposes of this by-law, the Corporation shall be deemed to have requested a person to serve an employee benefit plan where the
performance by such person of his or her duties to the Corporation also imposes duties on, or otherwise involves services by, such
person to the plan or participants or beneficiaries of the plan, and excise taxes assessed on a person with respect to an employee benefit
plan pursuant to applicable law shall be considered indemnifiable expenses. For purposes of this by-law, the term "Corporation" shall
include any legal successor to the Corporation, including any corporation which acquires all or substantially all of the assets of the
Corporation in one or more transactions.
(10.2) Insurance For Indemnification of Directors and Officers. The Corporation shall have the power to purchase and maintain
insurance for its Directors and Officers subject to the provisions of Section 726 of the Business Corporation Law of New York.
13
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
ARTICLE 11 - AMENDMENTS
(11.1) By Directors : The Board of Directors shall have power to make, adopt, alter, amend and repeal, from time to time, by-laws of the
Corporation; provided, however, that the shareholders entitled to vote with respect thereto as in this Article X above-provided may alter,
amend or repeal bylaws made by the Board of Directors, except that the Board of Directors shall have no power to change the quorum
for meetings of shareholders or of the Board of Directors, or to change any provisions of the bylaws with respect to the removal of
directors or the filling of vacancies in the Board resulting from the removal by the shareholders. If any bylaw regulating an impending
election of directors is adopted, amended or repealed by the Board of Directors, there shall be set forth in the notice of the next meeting
of shareholders for the election of directors, the bylaw so adopted, amended or repealed, together with a concise statement of the
changes made.
ARTICLE 12 -WAIVEROF NOTICE
(12.1) Shareholders. Whenever any notice is required to be given by law, the Certificate of Incorporation or these Bylaws to the
shareholders of the Corporation of a meeting of shareholders, a written waiver of notice submitted to the Corporation before or after the
meeting or the attendance at the meeting by any shareholder, shall constitute a waiver of notice of such meeting, except when the
person attends the meeting for the express purpose of objecting to the lack of notice thereof, prior to the conclusion of the meeting.
(12.2) Directors. Whenever any notice is required to be given by law, the Certificate of Incorporation or these Bylaws to the Directors of
the Corporation of a special meeting of the Board of Directors, a written waiver of notice submitted to the Corporation before or after the
meeting ox the attendance at the meeting by any Director, shall constitute a waiver of notice of such meeting, except when the person
attends the meeting for the express purpose of objecting the lack of notice thereof, prior to the Commencement of the meeting.
(13.l) Form. The seal of the Corporation shall be in the form impressed in the margin.
ARTICLE 13 - SEAL
(13.2) Use. The seal may be used by causing it to be impressed directly on the instrument or writing to be sealed, or upon an adhesive
substance annexed. The seal on certificates for shares or other documents may be a facsimile, engraved or imprinted.
ADOPTED BY THE BOARD OF DIRECTORS AS OF MARCH 18, 2010
14
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EX-10.38 29 v216851_ex10-38.htm
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EX-21 37 v216851_ex21.htm
Exhibit 21.0
Document Security Systems, Inc. acknowledges that the following corporations are subsidiaries of the Registrant:
SUBSIDIARIES OF REGISTRANT
Name
State of Incorporation
Document Security Consultants, Inc.
Thomas M. Wicker Enterprises, Inc.
Lester Levin, Inc.
Secured Document Systems, Inc.
Plastic Printing Professionals, Inc.
Secuprint, Inc.
Premier Packaging Corporation.
(New York)
(New York)
(New York)
(New York)
(New York)
(New York)
(New York)
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EX-23.1 38 v216851_ex23-1.htm
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Exhibit 23.1
We consent to the incorporation by reference in Registration Statement No. 333-134034 (Form S-8) and Registration Statement
No. 333-128437 (Form S-8) and Registration Statement No. 333-116317 (Form S-3), Registration Statement No. 333-125373 (Form S-3),
Registration Statement No. 333-141871 (Form S-3), Registration Statement No. 333-166357 (Form S-3) and Registration Statement No.
333-171940 (Form S-3) of Document Security Systems, Inc and Subsidiaries of our report, dated March 31, 2011, on the consolidated
financial statements as of and for the years ended December 31, 2010 and 2009, appearing in this Annual Report on Form 10-K of
Document Security Systems, Inc. and Subsidiaries for the year ended December 31, 2010.
/s/ FREED MAXICK & BATTAGLIA, CPAs, PC
Buffalo, New York
March 31, 2011
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EX-31.1 39 v216851_ex31-1.htm
Exhibit 31.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Patrick White, certify that:
1. I have reviewed this annual report on Form 10-K of Document Security Systems, Inc.
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with
respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in
all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act
Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on
such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s
most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control
over financial reporting; and
5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
Date: March 31, 2011
/s/ Patrick White
Patrick White
Chief Executive Officer
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EX-31.2 40 v216851_ex31-2.htm
Exhibit 31.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Philip Jones, certify that:
1. I have reviewed this annual report on Form 10-K of Document Security Systems, Inc.
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with
respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in
all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act
Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on
such evaluation; and
d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s
internal control over financial reporting; and
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors:
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
Date: March 31, 2011
/s/ Philip Jones
Philip Jones
Chief Financial Officer
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EX-32.1 41 v216851_ex32-1.htm
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Document Security Systems, Inc. (the “Company”) on Form 10-K for the year ending
December 31, 2010 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Patrick White, Chief
Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-
Oxley Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations
of the Company.
Date: March 31, 2011
/s/ Patrick White
Patrick White
Chief Executive Officer
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.
EX-32.2 42 v216851_ex32-2.htm
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Document Security Systems, Inc. (the “Company”) on Form 10-K for the year ending
December 31, 2010 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Philip Jones, Chief
Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that to my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations
of the Company.
Date: March 31, 2011
/s/ Philip Jones
Philip Jones
Chief Financial Officer
EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved.